The importance of saving for retirement has been really driven home over recent years, particularly with the auto-enrolment campaign (“We’re all in”). Here is a quick look at the four types of pension and what happens to them upon the holder’s death.
The state pension
A state pension is given to an individual (even though there are certain circumstances in which a person may be able to claim a state pension based on another person’s contributions). Therefore, it ends upon the death of that individual.
Defined benefits pensions
These operate to their own set of rules and hence holders of such pensions would need to check what happens to them upon their deaths.
The key point to remember about buying an annuity is that once it is bought it is a done deal. Therefore, if it is important to you that there is at least the option of your nearest and dearest receiving a legacy from your pension fund after your death, you need to look into this before buying your annuity since it is too late to do it afterwards.
Pensions based on income drawdown
Since “pensions freedoms day”, holders of pension pots have been able to bypass the traditional annuities route and use their pension funds essentially as standard investment funds with which to generate an income. Depending on the investor’s success, there may or may not be capital left over upon their death. If there is, they are now able to pass the funds onto their chosen beneficiary or beneficiaries by means of a scheme called Nominee Flexi-Access Drawdown and then when the chosen nominee(s) die(s), they can pass it on to their chosen beneficiary by means of a scheme called Successor Flexi-Access Drawdown. Under current rules, this process can essentially continue indefinitely, as long as there are funds left in the pension fund.
In addition to the obvious benefit of being able to pass on your assets to those you love rather than simply handing them back to the company behind an annuity, there is the further benefit that the pension fund itself is excluded from the calculation of the value of the estate for the purposes of inheritance tax calculation. What’s more, if the current holder of the pension fund dies before their 75th birthday, subsequent drawdowns (withdrawals) will be paid out free of income tax. After that age, they are taxed as income but still free of IHT.
NB: the Nominee Flexi-Access Drawdown scheme was introduced in April 2015, after the initial pensions freedoms, hence existing plans may not be set up to accommodate the scheme. It is therefore recommended to check promptly whether your current pension scheme has this option and if not to take professional advice as to your best options.
A final point about pensions
There is a major difference in meaning between the words can and should. You can choose to use income drawdown to fund your retirement and if you do you may have capital left over to bequeath to your chosen beneficiaries. At the same time, however, it’s important to remember that the whole purpose of retirement funds is to fund your retirement and that any legacy you can leave is a bonus, which will benefit someone else rather than you. It’s also important to remember that it may still be possible for you to leave a legacy even if you go down the route of an annuity-based pension, you would just have to look at other options for doing so. Annuities-based pensions are still a valid way of ensuring an income in retirement and for some people may be a far superior option to income drawdown (whereas for others they may be a terrible choice). It is therefore strongly recommended to take professional advice before making any major decisions with regard to your retirement.
The value of pensions and investments and the income they produce can fall as well as rise. You may get back less than you invested.
Transferring out of a Final Salary scheme is unlikely to be in the best interests of most people.