Some people believe that saving into a pension scheme is pointless because they may not even reach retirement. So whats the point? Others see the many benefits of saving into a pension but are unsure of what happens to the fund if they die. I hope this blog opens your eyes to the legacy you can leave to a loved one through investing tax efficiently into a pension.
Before we get to what happens to your pension if you die now, its important to understand the rules pre pension freedom changes in 2015. This will help to understand why some people have a incorrect understanding that I'll save all my life and the pension company will benefit if I die early. Pre 2015 you had to draw your pension before age 75. This would mostly be in the form of taking 25% of the fund as a tax free lump sum and then using the remaining 75% to buy an income for life known as an annuity. If you died before you drew your pension then your spouse would get 100% of the fund as a tax free lump sum, great!. Not so great though, if you died after handing over 75% of your life savings to an annuity provider then that could mean the end of the contract and the annuity provider keeps the remaining money. This means you could save your whole life and only get a few months return if you had a sudden accident straight after buying the annuity without any widow benefits or guarantees.
Pension freedoms in 2015 changed it all and revolutionised pensions from being just a vehicle to save for your retirement to being a legacy planning tool. George Osborne the chancellor at the time changed the rules "trusting those people who have worked hard and saved all their lives" (Quote1) to make the right decisions for them for their pension . This mean't you no longer had to hand the 75% to a annuity provider who would tell you what income you can have. You can now draw money directly from a type of pension know as a draw down pension.
A draw down pension works just the same as the standard pension you have been building your funds in expect it allows you to draw money from it. This could be in the form of a regular income, ad hoc lump sums or even draw the whole fund in one go. Every time you make a withdrawel you will be issued with a payslip. The income is subject to income tax so its worth taking advice before making any hasty decisions that could trigger you paying more tax than you need to. This responsibility comes with risk. If you draw to much your fund could run out leaving you in financial hardship later in retirement so advice is recommended. But the positive is now you can have a flexible retirement changing the income as you needed.
Pensions freedoms also changed the rules around death for funds in a drawdown or regular pension. The rules change slightly on your 75th birthday. The following rules are the same if your in the building phase of saving into a pension or if your in the drawdown phase of taking an income.
The great news is if you die before the age of 75 then 100% of your money that's left will be left to your chosen beneficiary. Your chosen person or persons will get the remaining money as a tax free lump sum.
The good news is your chosen person will still receive your pension but they will now inherit the money as a PENSION POT. When you inherit a pension pot every time you take funds from the pension the provider will issue a payslip and P60. This means your chosen person will pay income tax as they draw the funds. It's sensible to take financial advice if your ever lucky enough to inherit such a pension! You can then leave an inherited pension to the next generation as a pension pot and they can leave to their benefices and so on. Its a great intergeneration vehicle to transfer wealth.
Now we have established that the pension provider has to pay the funds out on your death how do they know who to pay the money to?
This is done through a nomination form. When you set up a pension and throughout the life of your pension you should complete and maintain a nomination form with the provider. A nomination form is like a mini will that sits along side the pension directing the provider who they should pay funds to on your death.
If a nomination form has not been completed or the form fails because all your nominated people have died then the provider will make a decision on who to pay the funds to. If no obvious decision can be made they will pay the funds to your estate and the pension will be distributed along with all your other assets and belongings. On this note its important to also have an up to date Will!
As long as the provider pays the funds directly to a person and not into your estate then the funds are not subject to inheritance tax. This has made pensions very attractive to the rich and wealthy as a tool to reduce inheritance tax payable which is at a rate of 40% for 2021/2022.
Pensions enable people to build and save tax efficiently. With pension freedoms you have reassurance that if you work hard all your life and are unlucky enough to die before you have taken back the benefits you will leave a legacy to your chosen loved ones. There are lots of options and factors to consider both in the savings phase and the draw down phase so advice is recommended and of course we are happy to help!
I write here about the more common defined contribution (DC Schemes) pension scheme. The other type is a final salary or defined benefit scheme (DB Schemes). The NHS, Police, Teachers are all DB schemes. Some bigger companies historically offered DB schemes they have mainly been replaced. I explain this because DB schemes have different rules on death so you need to refer to the scheme rules or seek advice.
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Quote 1 - https://www.bbc.com/news/uk-31892518