Many of us consider our home to be our most valuable asset and the most important factor to consider when planning what we want to happen and who we want to look after if we die. However, if you have been contributing to a pension for some time, you may have amassed a sizable “pot,” which you should consider.
How it is handled when you die is determined by the type of pension and the rules that govern it. So it’s well worth learning about it and planning ahead of time.
In general, there are two types of pensions: defined benefit, also known as final salary, and defined contribution, also known as personal pensions. They operate in very different ways.
Defined benefit schemes are disappearing and are now mostly found in government jobs or large corporations. Essentially, the pension scheme will pay you an annual pension that is usually linked to your earnings and years of service. You can frequently agree to take a lump sum in exchange for a lower annual pension, but there is usually no “pot” of money that you own and can leave to your beneficiaries.
If you die, there is often provision for a spouse or other dependents pension, which is paid to your spouse at a lower rate, for example. A death benefit lump sum is sometimes paid, but it depends on the scheme’s rules and when you die. When planning to provide for your family and dependents, it is critical to understand the rules and benefits available through your pension plan. If your plan requires you to nominate beneficiaries for any benefits, you should do so and keep those nominations current.
The other major type of pension is a defined contribution scheme, in which you accumulate a pot that is usually invested. The amount you receive when you retire is determined by the size of your retirement fund. Trustees manage the pension and decide where your pension pot should go if you die before it runs out. They do, however, consider any expressions of wishes or nominations you have made. As a result, it is critical to ensure that you have made a nomination and that you keep it up to date. Unlike with final salary pension schemes, you can usually leave your pot to a broader group of people, such as your children or even charities.
Because the state pension is a personal entitlement, you cannot leave it to anyone. In some cases, your spouse can benefit from your national insurance contributions and receive a pension. So, once again, it is worth finding out what they would receive in the event of your death and factoring that into your planning.
Another important aspect of pensions is that they pass outside of your estate. As a result, you cannot leave them in your Will, but they are exempt from inheritance tax. The nomination to your pension trustees is how you decide who they go to, and because they do not attract inheritance tax, they can be a way of inheritance tax planning.
If your estate is large enough that inheritance tax must be considered, it is important to understand your pension scheme rules and factor them into how you want to structure your estate. For example, some of the pension pot could be left to children, giving them an inheritance, while other assets, which would normally attract inheritance tax, could be left to a spouse, removing them from inheritance tax liability as well.
There are some complicated rules regarding what income tax beneficiaries may be required to pay depending on when you die, and we would recommend that you seek legal advice when estate planning because there are numerous other issues to consider. Our Wills and Probate team is knowledgeable in this area and can guide you through the process in a friendly and understandable manner.
The main takeaways are to consider your pension when assessing your assets and how your loved ones will cope if you die, even if you are not yet of pensionable age. Learn about the pension rules and make any nominations required by your pension scheme trustees.
