What happens to my pension when I die?

Ruth Richards 

Investors will get their money back if they die within 90 days of buying a pension annuity with Aviva. This is great news, but what happens otherwise? 

One of the most common questions we are asked is 'What happens to my pension when I die?'

There are three main scenarios once you reach 55.

1. You haven't taken any tax-free cash or income yet

If you die before taking any tax-free cash or income, and you're under 75, your pension can normally be paid to your beneficiaries as a lump sum, free of tax.

Once you reach age 75 or take the tax-free cash or income, the position changes. The untouched pension can still be passed on to your beneficiaries as a lump sum but will be subject to a 55% tax charge. Alternatively the fund can be used to provide your spouse or dependants with a taxable income. 

2. You choose an annuity

An annuity is a secure, regular taxable income purchased from an insurance company in exchange for your pension pot. The income is paid to you for life which is a great deal if you live a long time; not so great if you die early. An annuity will stop on your death unless you have chosen to protect the income. Once set up an annuity cannot be changed or cancelled so it's important to choose options carefully.

There are three main types of death benefits you can choose:

Continuing income to a spouse (joint life option) - Your annuity income will be paid to your spouse or partner for the rest of their life after your death. Options include 50% (your spouse receives half the income you were receiving), and two thirds spouse's pension. 

Payments guaranteed for a minimum period - You can select a guarantee period of up to 10 years. Income will continue to be paid until the end of the guarantee period, even if you die. Some annuity providers allow the payments to be made outside your estate for inheritance tax purposes (for example Canada Life, LV=, Just Retirement and Partnership have policies which currently allow this).

Money back option (known as value protection) - If you die before a certain age (normally 75) and the total gross income paid to you is less than the amount used to purchase your annuity, the balance will be paid to your beneficiaries, after a 55% tax charge.

Depending on your circumstances, you have the choice of selecting as many (or as few) of the above options as you wish. These options usually reduce the starting income to cover the cost of providing additional benefits. However, without purchasing death benefits your pension will be lost if you die early and your spouse or partner may be left short of income.

To add some protection for investors who do not include death benefits in their annuity, one annuity provider, Aviva, will now offer a free 90 day value protection benefit for new annuities, as well as a minimum one year guarantee period. These benefits are free and will not reduce the starting income.

Find out more about annuity options

3. You choose income drawdown

income drawdown allows you to keep control of your pension fund, choose where it is invested and draw a variable, taxable income. The death benefits under income drawdown are more flexible than an annuity and do not have to be decided at outset. This flexibility is one of the main reasons investors consider income drawdown, however it is a higher risk alternative to an annuity and is not suitable for everyone; poor investment performance and excessive income withdrawals can deplete the fund leaving you short of income. If you are at all uncertain about its suitability for your circumstances we strongly suggest you seek advice.

When you die your beneficiaries have the following options for the remaining drawdown fund:

Take the remaining fund as a lump sum, subject to a 55% tax charge.

Your dependant can continue with income drawdown. The fund is passed on without any tax charge. Any income taken is taxable at their personal income tax rate.

Your dependant can use the remaining pension to take flexible drawdown provided they meet the set criteria, (including being in receipt of at least £20,000 secure, annual pension income). Any money taken out as flexible drawdown is taxable at their personal income tax rate.

Your dependant can buy a lifetime annuity with the remaining fund. No tax charge is applied to the remaining fund if the full amount is made available to buy the annuity.

A lump sum could be paid to your nominated charity. If you have dependants this payment will be subject to a 55% tax charge. If there are no dependants the payment is free of tax.

Please note, the amount of tax relief and the value of tax shelters will depend on your own circumstances and tax rules can change over time.