What happens to your pension when you die
Since April 2015, pensions have become more flexible than ever before including significant changes to the tax treatment of remaining pensions on death.
There is now more choice and more freedom for passing on pensions to loved ones. But more choice means more difficult decisions; especially if the decisions you make now could affect your loved ones after you’re gone. Below we explain the factors to consider when making a decision and the options available to you and your beneficiaries.
What happens to your pension when you die, and the options available to your beneficiaries, will depend on how you take your pension and at what age you die. Investors should remember to plan for the future and ensure their income will sustain their retirement.
Remember your circumstances, and those of your loved ones, can change as you get older, particularly due to health and care needs. For those who have dependants to think about this may play an important role when deciding how to access a pension.
Drawdown allows you to retain control of your pension by keeping it invested, and usually take up to 25% of the pension as a tax-free lump sum up front. There is no limit on the subsequent drawdown income that can be taken, but it is taxable.
The tax-free cash taken is yours to save or spend as you choose. Some savvy investors may choose to keep some of the cash as a buffer for income during volatile markets, others may use it for one-off expenditures such as a family wedding or house purchase.
Alternatively, unlimited lump sum withdrawals (also known as an Uncrystallised Funds Pension Lump Sum) can be taken directly from your pension. 25% of each withdrawal should be tax free, and the rest is taxable. As with drawdown, income is not guaranteed. You control and must review where your pension is invested, and how much income you draw. Your income is not secure and it could reduce, or even run out, if investments don't perform as you hoped, you withdraw too much or you live longer than expected.
Any funds left when you die can be taken by your beneficiaries as a one-off lump sum or in stages as income. The tax treatment will depend on the age at which you die (which is explained below).
|How can your pension be passed on?||If you die before age 75||If you die age 75 or older|
|As a one-off lump sum||Free of income tax||Taxed as income*|
|As income** - via an annuity or drawdown||Free of income tax||Taxed as income*|
*Income is taxed at the beneficiary’s/beneficiaries’ rate of income tax.
**Option only available to dependants or nominated beneficiaries.
Prior to 6 April 2015, a massive 55% tax charge could be applied if you died having reached age 75 or when in drawdown.
Now it doesn’t matter if you move the pension into drawdown or take a lump sum, and there’s no need to worry about that 55% tax charge.
If you die before reaching age 75 the remaining money can be passed on tax free. Even if you die after age 75, your beneficiaries will in most cases just pay income tax on the money they receive.
Our factsheet explains the rules in plain-English:Download our factsheet: find out more about your beneficiaries’ choices
An annuity is a secure regular income purchased from an insurance company in exchange for part or all of your pension. Usually up to 25% of the pension can be taken first as a tax-free lump sum. The remainder purchases the annuity which pays a guaranteed income for life, which is taxable.
Please note: Once set up an annuity cannot normally be changed or cancelled, so it's important to choose your options carefully.
The income will stop on your death unless you choose one, or a combination of, the below features when you originally set up your annuity.
As above, the amount of tax your beneficiaries pay will depend on the age you die; if you die before age 75 any continuing income payments or lump sums are usually tax free, and if after age 75 the beneficiaries will pay income tax on the money they receive.Download our factsheet: find out more about your beneficiaries’ choices
In order to ensure your wishes are clear, pension providers may ask you to nominate your chosen beneficiaries. In the HL SIPP (Self Invested Personal Pension), investors are encouraged to complete an Expression of Wish form allowing them to nominate the person or people to whom they would like their SIPP fund paid after their death. This is not legally binding, but gives an indication of their wishes, and can be changed at any point.
In most cases pensions are free of inheritance tax (IHT) as they are typically held in trust outside your estate. Pension contributions made while in ill health or within two years of death may still be liable to IHT. HMRC require benefits from a pension to be set up within two years of the pension provider becoming aware of the investor’s death for them to remain tax-free, where applicable. Tax charges may also apply if you exceed the lifetime allowance and die before age 75. Pension and tax rules can change and benefits depend on circumstances.Free factsheet download: what happens to your pension when you die
What you do with your pension is an important decision. Therefore, we strongly recommend you understand your options and check your chosen option is suitable for your circumstances: take appropriate advice or guidance if you are at all unsure.