The subject of adding beneficiaries to your pension is a crucial one to consider, but it can be complicated. There is a general misconception that your pension dies with you. In certain circumstances, it does, but in many scenarios, you can pass your pension benefits to your beneficiaries. There are many factors to consider, such as type of pension, age, and whether benefits have been taken.
There is a slight difference in the approach to beneficiaries with a defined benefit pension scheme (final salary) and a defined contribution pension scheme (money purchase). With a final salary scheme, you may find that the scheme rules strictly define a spouse, civil partner or dependent as potential beneficiaries. The situation with a money purchase scheme is different. You tend to find there are few, if any, restrictions on who you can name as a beneficiary to your pension. It is also worth noting that you can name more than one beneficiary of your pension benefits.
When looking to name beneficiaries to your pension benefits, you should consult with a financial adviser and take into account specific pension scheme rules.
Within the boundaries mentioned above, you can, in theory, change the beneficiaries to your pension benefits as often as you like. A recent report by Which magazine about pension beneficiaries, estimated that circa 750,000 people in the UK are currently at risk of passing their pension benefits onto the “wrong” beneficiaries. The most common issue is a failure to update pension records upon a change in personal circumstances such as separation/divorce. When carrying out regular reviews of your finances, consider your pension assets and appointed beneficiaries.
If you have no named beneficiaries to your pension upon death, it is up to the pension fund trustees to nominate a suitable benefactor(s). Their first port of call would be the individual/executive sorting out your financial affairs. Unfortunately, having no named beneficiaries to your pension benefits could lead to legal challenges by various parties.
When starting your pension fund, you will be invited to complete what "expression of wish" or "nomination beneficiaries" forms. The pension fund trustees will consider these nominations as your chosen beneficiaries. Interestingly, there is no legal obligation for the pension trustees to accept and act upon your benefactor instructions. In the vast majority of cases, the pension trustees will carry out your instructions to the letter. Still, there may be occasions where there is some concern. The trustees may believe that you have been pressurised into changing your beneficiaries or perhaps you are acting out of character. These flags tend to emerge where strangers have replaced family members.
There are some occasions where your pension cannot be transferred and effectively dies with you. Thankfully, in the majority of cases, a full or partial transfer of your pension benefits can be made to your chosen beneficiaries. There are several scenarios to consider, such as:
If you die before your 75th birthday and have yet to start taking personal pension payments, the transfer to beneficiaries would be tax-free. Where pension payments had commenced (not via an annuity), and the balance claimed within two years of death, this would be transferred to your beneficiaries free of tax. If claimed out-with this timescale, income tax would be charged. The pension could be taken as a lump sum or via ad hoc or regular drawdowns.
If you were to die on or after your 75th birthday, your beneficiaries would pay income tax on all pension payments. Subsequent pension payments would be added to their annual income and the appropriate level of income tax charged. Where significant pension assets are transferred to beneficiaries, a lump sum payment may take them into a higher tax bracket. As a consequence, it is sensible to take financial advice in this scenario.
Where pension fund assets have been used to acquire an annuity, creating a guaranteed income for life, this normally ends on your death. However, if you took out a joint annuity, then the surviving party would continue to receive their pension. On the death of the surviving party, all pension benefits would die with them. There are also other types of annuity, such as those with a guaranteed period or capital protection.
An annuity with a ten year guarantee period would continue to pay the pension to a beneficiary if the ten year period had not expired. So for example, if you died eight years into a guaranteed period, your beneficiaries would receive the pension for a further two years. If the guaranteed period had expired, pension payments would cease, and there would be no assets available for transfer.
On occasions, you will come across capital protected annuities, often referred to as “value protected” annuities. This arrangement protects the remaining capital within your annuity pot, which has not yet been paid out as pension income. So, if you acquired an annuity for £50,000, but had only received £25,000 in pension benefits before your death, your beneficiaries would receive £25,000.
There are two distinct scenarios when considering your beneficiaries and defined benefit pensions:
If you die before retirement, your workplace pension will pay out a lump sum to your beneficiaries. This is traditionally between two and four times your final salary but will depend upon scheme rules. The payment is tax-free if you are under 75 years of age at death. Traditionally, works pension schemes will also pay a “survivor’s pension” which will attract tax at the beneficiary’s marginal rate.
Where death occurs after retirement, the majority of defined benefit pension schemes will continue paying a pension to your spouse, civil partner or another dependent. This will be a reduced pension which will again be dependent on the individual scheme rules.
Upon your death, pension assets will not be included as part of your estate when calculating inheritance tax. Any funds, lump sum or draw down, withdrawn from your pension scheme but as yet unspent would be classed as part of your estate.
While not common knowledge, it is possible to pass on part of your state pension to your spouse or civil partner upon your death. If you reached state pension age before 6 April 2016 and received the basic state pension, your spouse or civil partner may be able to claim your additional state pension. The additional state pension element is based upon your national insurance contributions record.
Where you deferred your state pension, your spouse or civil partner would be eligible to receive the extra state pension. If deferred for 12 months or more, your spouse or civil partner would have the option of a lump sum payment or additional state pension. A deferral of shorter than 12 months would remove the possibility of a lump sum payment.
If you achieved state pension age on or after 6 April 2016 and received the new state pension, your spouse or civil partner may be eligible for an extra payment on top of your pension. Eligibility for additional payments is not straightforward and financial advice should be taken.
In theory, you, as the ultimate owner of your pension assets, can add or change beneficiaries at any point. While pension fund trustees are not legally obliged to act upon your beneficiary instructions, they would need a strong reason not to do so. The role of pension trustees is simple, to protect your assets and take the necessary action.
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