Planning for retirement often centres on building a comfortable income, but a critical aspect frequently overlooked is what becomes of your pension after you pass away. Understanding the inheritance rules for different pension types is vital for effective estate planning and ensuring your wishes are fulfilled.
The State Pension: Complex Inheritance Rules
The basic state pension, which requires being 66 or older with sufficient National Insurance contributions, generally cannot be inherited. However, the situation grows more intricate with the Additional State Pension. This component, for men born before 6 April 1951 and women born before 6 April 1953, operates under different inheritance rules.
A surviving spouse or civil partner's own National Insurance record and any deferred state pension payments can also affect what benefits, if any, continue. For instance, if death occurs before reaching the state pension age, a surviving partner who is also below pension age might be eligible for extra benefits.
For those who pass away after reaching pension age, the rules diverge. Under the pre-2016 system, a partner might inherit a portion of the Additional State Pension. Those on the post-2016 system could be entitled to increased pension payouts. Furthermore, if the state pension was deferred, the surviving partner may receive a lump sum or enhanced payments on their own pension.
Inheriting Private Pensions: A Different Landscape
Private pensions function very differently and are often inheritable. Workplace pensions primarily fall into two categories, as explained by Fiona Peake, a personal finance expert at Ocean Finance.
Defined Contribution Pensions
With a defined contribution (DC) pension, the focus is on the pot of money you've accumulated. If you die before age 75, your beneficiaries can typically access the funds tax-free, provided the payout occurs within two years. If you die after 75, they will likely pay income tax on withdrawals at their own rate.
A crucial step is nominating your beneficiaries. If you have named them with your pension provider or in your will, they will receive the pension under these conditions. If no beneficiary is named, the provider may decide, and the funds could become part of your estate, potentially making them liable for inheritance tax.
If you've started drawing your pension, the method matters. With a drawdown option, any remaining funds can usually be inherited, often as a lump sum or a continued income. If you purchased an annuity, the terms are key. A basic annuity stops at death, but a joint or guaranteed term annuity might provide ongoing payments to a spouse or dependants.
Defined Benefit Pensions
Defined benefit (DB) pensions, or final salary schemes, provide a guaranteed income. Upon death, some schemes may pay a percentage of this income to a spouse, partner, or dependants. The specific rules vary by scheme, so checking with your provider is essential. If a spouse isn't listed, payments typically stop unless the scheme allows for dependants like children.
Upcoming Changes and Essential Planning
Pension rules are set for a significant shift in April 2027, which will impact how pensions are taxed after death. Joshua White, Head of Growth at Level, highlights that currently, most unused pension funds are exempt from inheritance tax. From April 2027, these funds will be included in the value of your estate for inheritance tax purposes.
This change will particularly affect individuals on defined benefit schemes. Mr White estimates that around one million UK properties currently below the inheritance tax threshold could become liable due to these changes and fiscal drag.
To safeguard your legacy, experts strongly advise nominating your pension beneficiaries and keeping those details updated, especially after life events like divorce or remarriage. For personalised guidance tailored to your circumstances, contacting the Pension Service or consulting a financial adviser is highly recommended.
