What Happens to My UK Pensions Upon Death?

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Planning for the future is not just important, it's essential for having a secure lifestyle. Since we cannot live forever (yet), understanding what happens to UK pensions upon death is crucial for effective financial planning. In this article, I will break down what happens to both defined contribution (DC) and defined benefit (DB) pensions when the pension holder passes away.

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The Difference Between DC and DB Pensions

What is a Defined Contribution Pension

Defined contribution pensions are pensions funded by contributions made into a pension pot by either you, your employer, or both. These contributions are then typically invested to grow over time. For more information on this type of pension and how it works as an expat, please contact me directly using the links at the bottom of this article.

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What is a Defined Benefit Pension

Defined benefit pensions provide a guaranteed inflation-linked-income in retirement based on your salary with the employer and the number of years you've worked for your employer. Defined benefit pensions are not invested pots, but rather will have capped growth in line with UK inflation (either RPI or CPI) and are guaranteed by the employer. These pensions can also be known as final salary pensions or guaranteed pensions. For more information on this type of pension and how it works as an expat, please contact me directly using the links at the bottom of this article.

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What Happens to my Pension Upon Death?

This will depend on if you have started taking benefits or not and the type of pension you have. Below, this is broken down separately for the individual pension types:

Defined Contribution

A Quick Disclaimer

In defined contribution pensions, you can take the benefits either as an annuity or as a flexi-access drawdown. Which options you have will depend on your pension provider and what they can offer. Here we will be looking at the options assuming you have flexi-access drawdown, as if you take an annuity, you have essentially sold your pension to an annuity provider and will then receive an income (an annuity) from the annuity provider in retirement until death.

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Following the death of the annuity holder, the income will either stop or continue to be paid out. This will depend on the type of annuity that the pension holder elected to take out and the age of the beneficiaries at the time of the annuity holder's death. Typically, the pension will die with the annuity holder unless they choose to take a lower rate of income for some added benefits or have beneficiaries that are young enough to be eligible to continue to receive the annuity. Thus, this can become very complex with many different variables, so we will not be exploring this here.

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Please feel free to contact me directly using the links at the bottom of this article if you would like more information on how an annuity works.

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The Beneficiaries’ Options

Upon the death of the pension holder, the beneficiary will have two options:

Option 1 - take the remaining pension out as a cash lump sum.

Option 2 - keep the funds in the pension and become the inherited pension holder to receive benefits in retirement.

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Which Option is Better?

This will depend on the beneficiary’s personal situation and needs. However, Option 2 would typically be the more efficient option for passing on wealth through death due to how the pension is taxed differently. This is broken down in more detail below.

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Tax Implications

Option 1 - If the beneficiary elects to keep the pension in the pension wrapper, this could then fall outside the taxable estate upon death. This means that the beneficiary would only need to pay income tax as they make withdrawals from the pension in retirement. This is not unlike how you would have been receiving the benefits.

Option 2 - If you die before age 75, beneficiaries could potentially receive the remaining funds tax-free. But if you die after 75, the remaining pension is typically subject to income tax based on the beneficiary's tax band.

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All of this can vary depending on where you and your beneficiaries live. For more detailed or tailored information on how your pension may be affected, please contact me directly using the links at the bottom of this article and I would be happy to provide a free breakdown based on your personal situation.

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Defined Benefit

A Quick Disclaimer

As the defined benefit pension is guaranteed by the employer where the pension was accrued, these benefits are subject to the defined benefit pension not falling into the PPF (Pension Protection Fund). A defined benefit pension might fall into the PPF if the pension scheme falls too deeply into a funding deficit or if the employer becomes insolvent. If this happens, the pension benefits can be reduced significantly depending on several different factors. As the change in benefits will depend on a complex series of factors specific to each defined benefit pension holder, we will not be exploring a pension in the PPF here.

If you have a pension in the PPF and would like some answers, please contact me directly using the links at the bottom of this article.

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Can My Beneficiaries Receive the Income?

Most defined benefit pensions provide a pension for your spouse, civil partner, or other dependent after you die. This typically amounts to about 50% of your pension income, but it can vary depending on the benefits provided by the scheme you hold (and the age of the beneficiaries should you be passing the pension onto children upon death). If you are survived by your spouse who then receives 50% of the income, this will typically continue until the spouse’s death, at which point the pension essentially dies with them as the benefits typically will not continue to be passed on.

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Lump Sum

If you had not yet reached retirement or started to take an income from the pension, a lump sum death benefit is often paid to the beneficiaries. This is typically calculated as a multiple of 20 times the expected defined benefit pension annual retirement income. For example, if you were expecting to receive a GBP 10,000 annual income in retirement from the pension, the beneficiary may be entitled to a GBP 200,000 lump sum gross of tax. However, this multiple will vary depending on current gilt yields, interest rates, and other internal scheme calculations.

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Some schemes can also provide a lump sum if the defined benefit pension holder dies within a certain period into retirement. However, this is less common and depends on the individual provider and their benefits.

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How Do I Plan for Death?

1. Speak to a professional financial adviser. Review your options with an adviser and how the pension is set up to ensure you and your beneficiaries are adequately covered. You may be okay to leave the pensions as they are, or you may need to transfer them to another provider who can offer the required benefits.
2. Review your benefits with your scheme(s) directly. You can often see a summary of the benefits you are entitled to by reviewing the paperwork or by calling the pension provider directly to ask. Remember that this will usually not show you your alternate options, which could be realized through transferring the pension to another provider.
3. Discuss with your beneficiaries. While death can be scary, it is an important discussion to have with your dependents to understand what they will need to be secure following your death. Once you know this, you can begin to plan effectively. If your beneficiaries are too young to have such a conversation, you may want to go back to point 1.

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Conclusion

It is essential to be proactive when considering death benefits. While it can be a difficult topic for some to plan for, if you have dependents that you want to safeguard in your passing, you must review what will happen upon death ahead of time to avoid any unforeseen or unwanted complications that could have been avoided. What these complications and options could be will depend on a wide variety of factors, so consider speaking to a financial adviser who can simplify the options you have depending on your personal situation.

Do you have any unanswered questions?

Feel free to reach out to me via LinkedIn or email me on [email protected]. I would be more than happy to offer some addittional information upon request, or to help you explore your specific?options.

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