Your Pension and Your Estate

Retirement planning is crucial for ensuring a comfortable future, and your pension plays a huge role. However, when writing a Will, you may overlook your pension entirely. Including pensions within your estate plan is key to ensuring your savings are distributed in line with your wishes and maximising the legacy you leave to your loved ones. 

This blog will cover how you can include pensions within your Will, the types of pensions available, and the Inheritance Tax rules around it. 

Including Your Pension Within Your Estate 

Legally, your pension isn’t included in your estate. However, you can still bequeath it to any beneficiaries of your choice, typically by contacting your pension plan provider and updating your beneficiary information. This may be called a ‘nomination of beneficiaries’ or an ‘expression of wish’ form.

It’s important to review your pension plan and understand the specific rules and regulations regarding the distribution of benefits in the event of death, as these can vary depending on the type of plan you have. For example, some defined benefit plans may not allow you to specify beneficiaries; instead, the benefits will be paid to your estate.

If you have been part of several schemes over your career, you should contact each provider and update your wishes. To make it easier for yourself and your loved ones, you can combine pensions into one pot to prevent future complications. 

Types of Pensions

There are a few different types of pensions available that can affect your estate: 

Defined Benefit Pensions 

A defined benefit pension pays your retirement income based on your salary and the time you were a scheme member. Defined benefit schemes include final salary and career average schemes and are generally only available in the public sector.

This type of pension often has rules that outline how your money would be paid to your beneficiaries. However, the rules differ for every company, so double-check with your provider. 

After you pass away, your pension could be paid to:

  • Your spouse
  • Your children, if they are under twenty-three and in full-time education
  • Your children, if they are physically or mentally impaired
  • Anyone financially dependent on you, including partners not in a civil relationship with or married to you

Defined Contribution Pensions 

This type of pension is based on how much you and your employer contribute and how much this has grown over the years. It is also known as a money purchase scheme and includes workplace and personal pensions. 

You have several options as to how a defined contribution pension can be paid out when you pass away:

  • If no money has been taken – Your beneficiaries can access your money as a lump sum, set up an annuity (a guaranteed income), or establish a flexible retirement income. 
  • If you set up an annuity – An annuity is a guaranteed income for life rather than a pot of money. If you set up an annuity, what is payable to your beneficiaries will depend on the options you chose when you established it. If you selected a joint life basis, your partner would receive a portion of the income you were receiving. However, if you chose a single life annuity, any payments would stop when you passed away. If you pass away within the guarantee period of your pension, the income will go to your beneficiary until the period ends. If you only spend some of your pot on an annuity, the unspent portion will be inheritable as usual.  

State Pension

When you pass away, your State Pension will stop being paid. However, your spouse or civil partner may be able to inherit some. This depends on the National Insurance contributions you made and when you reached or will reach the State Pension age:

  • Additional State Pension – The State Pension used to be composed of two components: basic and additional. You might have accumulated additional money if you reached the State Pension age before April 6th, 2016. If you got married before that date, your spouse might be eligible to receive a part of it upon your death. If your spouse had already reached the State Pension age before April 6th, 2016 (or if they would have reached it on or after that date but passed away), you might be able to inherit a portion of their additional State Pension. Any additional inherited State Pension will be added to the surviving spouse’s payment.
  • Protected payments – You may have a “protected payment” if you acquired more State Pension than the new maximum before its implementation. This prevents a reduction in their benefits under the new system. Your “protected payment” is the amount by which your basic and additional State Pension combined exceeds the new State Pension. If you were married before April 6th, 2016, your spouse would receive half of your protected payment upon your death (and similarly, you can inherit half of theirs).

Pensions and Inheritance Tax

In the UK, Inheritance Tax (IHT) may apply to a pension plan if you pass away and leave the benefits to your beneficiaries. The amount of IHT owed depends on the total value of your estate, including your pension benefits and the specific rules and regulations of IHT.

IHT is payable on the value of an estate that exceeds the threshold, which is currently £325,000. Inheritance Tax is payable at 40% on the excess value for estates valued over this amount.

However, certain exemptions and reliefs may apply to pensions, such as the spouse exemption, which allows a surviving spouse to inherit it tax-free. If you pass away before the age of 75 and have a pension plan, the benefits you have accrued will typically be paid out to your designated beneficiaries in the form of a tax-free lump sum. The amount depends on the specific terms of your pension plan and may include the total of your contributions and any investment returns on them.

Your beneficiaries can receive the lump sum as a one-time payment or use it to purchase an income stream, such as an annuity, which provides a guaranteed income for life. If you pass away after the age of 75, the lump sum payment will be subject to income tax at the recipient’s marginal tax rate (the highest rate of income tax they pay).

Inheritance Tax rules and regulations, especially surrounding pensions, can be complex and may change over time. Therefore, it’s recommended to consult with a financial advisor or tax professional for more information on how Inheritance Tax may apply to your specific situation. Get in touch with The Planning Bee today to find out more about how our team of legal experts can help you with all your estate planning needs.

Getting expert legal advice with us is easy and hassle free

Once we recieve your details in the form below, we will contact you to arrange a FREE consultation