With the new tax year in April came some changes for pensioners. The state subsidy rose by 2.5 per cent and there was also an increase in Pensions Credit.
This means those claiming the new full state pension will now receive £179.60 per week, totalling a £228.80 bump for the 2021/2022 tax year.
Those on the old scheme will receive a £174 annual increase, equating to £3.35 more per week.
However, many people don’t know what happens to those pension savings when a person dies. Where does that money go and who gets any leftovers?
What happens to your State Pension when you die
If you’ve been paying National Insurance contributions throughout your life, your state pension won’t just disappear if you pass away.
A friend, family, or professional employed to look after that person’s finances will have to inform the Pension Service so that any future payments stop (don’t forget, you’ll also have to notify the bank if a person dies, too).
If you are married or in a civil partnership and are the one left behind, your pension may get a boost as a result of their death.
This entirely depends on their National Insurance contributions and the date they reached the state pension age.
If your spouse reached state pension age before April 6, 2016, you will need to contact the Pension Service to check what you can claim.
They may be able to top up your payments using your former partner’s contributions – which can be especially helpful if you have gaps in your National Insurance contributions because you were out of work, for instance.
If the deceased person reached state pension age on or after April 6, 2016, or were below state pension age when they died, you will need to speak to the Department for Work and Pensions to check any inheritance you may be able to access.
In cases where the person was single or divorced, part of the pension may go to their estate.
That’s providing the person died after reaching state pension age, and only if their state pension had not been claimed. In this circumstance, the estate can claim up to three months of the basic state pension.
If the person deferred their state pension, the remaining partner may be able to claim the extra state pension or get a lump sum.
What happens to private pensions
There are essentially two types of private pension – final salary or defined benefit schemes – where the sum is usually a multiple of salary and/or providing a pension for partners.
These are often described as the gold standard for pension provision but are increasingly rare.
And there are defined-contribution schemes (whether workplace or individual) where the pension pot is passed to family.
Defined contribution schemes are used as part of the auto-enrolment rollout and are now common, so if you’ve only recently joined a scheme this is likely to be the type you have.
Some people who have a DC scheme may have an employer who pays a defined benefit on their death, for example twice your salary.
With final-salary pensions, most schemes will pay out a lump sum to a beneficiary (typically your spouse but it may be a child or other dependent) of a multiple of salary (eg two times basic salary). If you die before the age of 75 this is paid tax-free, as long as the scheme pays the money out within two years.
This type of pension will also pay your spouse, civil partner or dependent child an income, usually around 50 per cent.
This is taxed as income and stops when the spouse or inheriting dependent dies. If you’re not married it’s worth checking if your scheme will pay to a cohabitee. Most now will but some schemes will still only pay to a legal spouse or civil partner.
If you have this type of pension, it is vital that you have registered an up-to-date expression-of-wish form.
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This helps the trustees of the pension to pay any lump sum to the beneficiary you decide, although who receives the money is normally at the discretion of the trustees. The form also helps avoid unnecessary tax charges.
It is easy to lose track of pensions, so if a spouse or partner wants to check if the deceased had any pension provision they need to contact the pension tracing service.
If you are single, divorced or have no dependent children, then it is worth thinking about what you might want to happen in the event of your death – while there may be no pension payable, a lump sum may still be paid (eg a multiple of your salary) so an expression-of-wish form is arguably even more important in this case.
You can transfer out of the defined benefit arrangement to an individual pension which can provide far greater flexibility and choice in who could potentially inherit the pension. However, this involves a number of risks so you must seek financial advice before doing this.
Defined contribution pensions
The defined contribution or individual pension, which is now commonplace, is where you have your own ‘pot’ of money which is paid to family following death. However, some employers may still offer a multiple of salary like a final-salary pension, in addition, if an employee dies.
The pension freedoms have been described as a game-changer around how the pension pot is treated on death.
The pot can now be inherited tax-free and cascaded down generations, sometimes free of both income and inheritance tax charges.
Again, it is vital that you complete and keep updated an expression-of-wish form. This will help the pension provider decide where and who to pay any benefits to, and can speed up things considerably at a very difficult time.
It’s also important you keep this form up to date if personal circumstances change, for example on divorce.
Tax treatment on death with DC pensions depends on whether the policyholder dies before the age of 75 or from 75 onwards. If you are still working this is likely to be before 75 and in that case pensions can be inherited tax-free. If the policyholder dies after 75, any lump sum or income is taxed at the beneficiary’s marginal rate of tax when it is withdrawn from the pension.
In both cases death benefits paid before age 75 – either multiple of salary or from untouched pension savings – count towards the lifetime allowance, currently £1,073,100. So for some people who have higher salaries and higher pension savings this could mean a tax charge on benefits in excess of £1,073,100.