08 Aug 2013
Sandy Lawrence, Financial Adviser, provides an insight to one of the most common retirement questions: what happens to your pension when you are gone? Knowing the facts can help you provide for those you leave behind.
What Happens to Your Pension When You are gone?
It's one of the most common retirement questions: what happens to your pension when you are gone? Knowing the facts can help you provide for those you leave behind.
How your pension is treated will depend on when and how you use it when you retire; whether you need a secure income - an annuity - or prefer more flexibility but accept income is not guaranteed - a higher risk option known as income drawdown.
What happens if you haven’t taken tax free cash or income yet?
If you die before taking any tax-free cash or income, and you are under 75, your pension can normally be paid out as a lump sum, free of any tax charge.
Once you reach age 75, the position changes. The untouched pension can still be passed on to your beneficiaries as a lump sum but will be subject to a 55% tax charge. Alternatively the fund can be used to provide your surviving spouse or dependant with a taxable income.
Once you start taking tax-free cash, income, or both, the position changes. Death benefits will depend on how you are withdrawing the pension, and what features you have chosen, broadly as per our table of options. Tax rules are subject to change and will depend on your circumstances.
What happens if I choose an Annuity?
An annuity is a secure, regular taxable income purchased from an insurance company in exchange for your pension pot. The income is guaranteed to be paid for the rest of your life - providing valuable security. The flip side of this guarantee is that annuities are fixed; they cannot be changed or cancelled once they're set up so it's important to choose your options carefully, and shop around for the best rate.
When you set up your annuity you can choose what (if any) income will be paid after your death.
You can select a continuing income to a spouse or partner (called a joint life annuity). You can choose how much income they receive when you die. This could be useful if your spouse relies on you for income.
You can select a guarantee period of up to ten years. Your annuity will be paid out for the guarantee period even if you die early. This could be useful if you don't have any other “death benefits” and does not cost much to include (the cost depends on your age and health).
You could also build in a “money back option”, where any remaining fund is paid to your beneficiaries less 55% tax if you die before a set age.
What happens if I select Income Drawdown?
Income Drawdown allows you to keep control of your pension fund, choose where it is invested and draw a variable, taxable income. The options for passing on your pension under income drawdown are more flexible than an annuity and do not have to be decided at outset. This flexibility is one of the main reasons investors consider income drawdown, however it is a higher risk alternative to an annuity and is not suitable for everyone. You control and must review where your pension is invested, and how much income you draw within limits. Poor investment performance or excessive income withdrawals can deplete the fund, leaving you short of income. If you are at all uncertain about its suitability for your circumstances we strongly suggest you seek advice.
What are the options for Income drawdown customers?
How can income continue after death?
Your spouse/dependant can buy a lifetime annuity (providing a taxable income) with the remaining pension fund. If the full amount is used for this there is no lump sum tax charge when the pension pot is passed on.
Your spouse/dependant can continue to take a taxable income using income drawdown from your pension pot. If the full amount is used for drawdown there is no lump sum tax charge on your death.
Your spouse/dependant can go into flexible drawdown with the inherited pension pot, if they meet eligibility requirements. (including being in receipt of at least £20,000 secure, annual pension income). Any money taken out as flexible drawdown is taxable at their personal income tax rate.
Any return of pension fund on death?
Yes, you can nominate the person or people to whom you'd like to pass on the fund any time. If your pension is passed on as a lump sum it will be subject to a 55% tax charge. There is also the option to pass the pension to charity: if there are no dependants this is tax-free.