What happens to your pension when you die?

Jasmine Birtles - Money expert, financial journalist, TV and radio personality
Last updated 3^rd November 2023
9 min read

After you’ve spent decades saving and investing money to build your pension, you’re likely to want to make sure that it’s protected after you’re gone, particularly if you pass on before you get to enjoy that pension pot.

You don’t want your retirement money to be retained by the pension company!

So how can you make sure your loved ones inherit your pension funds when you die? This is a short guide on what could happen to your pension when you die, and how you can make sure it goes to the right people in the right way.

On this page:

• What happens if I die before I retire?
• What happens if I die in retirement?
• What about my State Pension?
• Annuities and death
• Pension vs. ISA: Which is better in death?
• How to manage someone’s pension once they’ve died

 

What happens if I die before I retire?

The rules about bequeathing your pension on death vary from pension company to pension company, depending on the product you have and your age when you pass away.

If you were to die before you retire, then in most cases, the entire value of your company or personal pension fund can be paid to your beneficiaries free of tax. This is because most pension plans are written ‘in trust’ by default.

In other words, the money in the fund is kept separate from your estate for Inheritance Tax purposes. In fact, this is one of the reasons why it’s helpful to put a lot of your retirement saving into a pension, as it can reduce your family’s inheritance tax bill.

Remember, if you want to make sure your pension gets passed on after your death, you need to let your pension provider know the contact details of any nominated beneficiaries.

The type of pension that you have can also affect what happens to it when you die. Any company pension you have will either be a Defined Contribution Pension (DC) or a Defined Benefit Pension (DB). Most pensions now are DC ones, but many people still have a DB pension waiting for them.

Defined contribution pensions

With defined contribution pensions (sometimes known as money purchase schemes), the benefits you receive will depend on the value of your pension pot when you draw your pension income.

If you die before you start taking your pension, the accumulated value of your pension pot could be passed on to your nominated beneficiaries as a lump sum. If you are under the age of 75 when you die, this sum is normally tax-free.

Check with your HR department or directly with the scheme administrator to find out how you can ensure that you've nominated beneficiaries and see how much they’d receive if you died.

Defined benefit pensions

Defined benefit pension (sometimes known as final salary pension scheme) gives you a set amount when you retire, depending on your salary and your length of service in the company.

If you die before you retire, a reduced pension may be payable to your spouse, partner, or children. However, the Trustees under the death in service schemes have discretion upon who to pay benefits to.

There may also be a death in service benefit available, typically four times your annual salary, but it depends on the individual pension scheme.

What happens if I die in retirement?

Defined contribution pensions

If you die in retirement with a defined contribution pension, the key thing that will impact how your pension is passed on to any beneficiaries is whether you’ve started drawing pension benefits.

If you die before your 75th birthday and haven't started drawing your pension, the value of your pension can normally be passed on to your beneficiaries tax-free. Your beneficiaries have two years to claim the benefits, after which point tax may be applied.

However, if you’ve already started drawing your pension, the rules are different.

For those that withdraw a lump sum and have cash remaining in their bank account outside a pension, these funds will be counted as part of your estate and may be taxed accordingly.

But, if you don’t take a lump sum, your beneficiaries can typically access whatever’s left in your pension entirely tax-free, which can be done by further drawdown payments or withdrawing a lump sum or buying an annuity.

The only change to this is that if you die aged 75 or older, your beneficiaries will need to pay Income Tax on any pensions you leave behind.

Defined benefit pensions

The main consideration with defined benefit pensions is whether you were already retired when you passed away.

A defined benefit pension will usually continue paying a reduced pension to a spouse, civil partner, or other dependents if previously requested by you. Individual schemes have their own rules about who classes as a dependent, so make sure to check with your pension provider first.

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What about my State Pension?

If you die before you reach State Pension age, then sadly there are no pension or death benefits available to your inheritors when it comes to the State Pension.

Annuities and death

It used to be that when you retired, you had to turn three-quarters of your pension pot into an annuity. This means that an insurance or pension company would turn your pot of cash into a regular payment that you would get every year until you died.

Nowadays, you don’t have to have an annuity, but many retired people like to have some or all of their pension pot paid to them in this way as it gives them the security of knowing that the money won’t run out before they pass on.

If you do have an annuity of any size, you’re allowed to make arrangements before you take it out to make sure that any remaining funds go to a nominated beneficiary in case of your death.

There are 3 ways to do this:

• Joint life with last survivor annuity. This is where you nominate a beneficiary to receive your annuity after you pass away. In this case, the payments will continue as long as either person is alive, although the second person tends to get a smaller pay-out.
• Annuity protection. This is an insurance policy that makes sure that your remaining funds go to the people you want to receive them after your death.
• Guaranteed term annuity. This allows you to buy an annuity for a guaranteed amount of time, generally between one and ten years, although some annuity providers may increase it up to thirty years. With this policy, if you die before the end of the guaranteed term, the people you nominate will get the money that’s left.

One thing to keep in mind for yourself, though, is that generally, if you have an annuity that can be passed on to someone else you will get a slightly lower amount each year while you are alive.

This is because annuities are worked out based on how long you’re expected to live: the longer that term is, the less you’re likely to be offered per year.

If it looks like that annuity will continue after you pass on, the annual payment is likely to be reduced by the provider.

Pension vs. ISA: Which is better in death?

ISAs were brought in by the Government in 1999 to help people save for their retirements. They can be seen as an add-on to pensions. They make saving and investing more tax-efficient, as do pensions, but they do it in a different way.

With pension payments, the Government adds the tax you would have paid on the money you put in but then counts the money you take out in retirement as taxable income. With ISAs, you don’t get any tax benefit when you put the money in, but you do get to take any gains made tax-free.

So if you’re wanting to look after your family financially when you’re gone – particularly a spouse or someone who will need the most help, the question is whether you should have most of your money in pensions or ISAs? Well, there are pros and cons to both.

Benefits of ISAs

If you have a surviving spouse or partner, they'll automatically inherit a one-off additional ISA allowance from you.

• Your ISA can continue to grow tax-free for up to three years after you die while the estate is being processed. This is known as a ‘continuing ISA’.
• You can leave your ISA to anyone. However, if your estate is worth more than £325,000, it will be liable to Inheritance Tax at 40% like any other asset.
• If you have a stocks and shares ISA, your executor will be able to instruct your ISA provider to either sell the investments or transfer them within the ISA.

Benefits of pensions

• With a pension, the benefits paid on death don't usually form part of the investor's estate, so they’re tax-free already.
• Plus, with new pension flexibility, it also means that it’s possible to pass funds down through the generations while keeping them invested tax-efficiently.
• For most people, inheriting a combination of both ISA and pension funds would be a good bet, because that way, beneficiaries can receive the benefits of both.

However, it’s a really good idea to speak to a financial advisor when you're managing your estate and will - this can ensure you are looking after your dependents in the best way.

You can get a free session with a recommended advisor through VouchedFor.co.uk(offers.vouchedfor.co.uk opens in a new tab) and MoneyMagpie.com(www.moneymagpie.com opens in a new tab).

How to manage someone’s pension once they’ve died

As many pension schemes provide death benefits, if you are the executor or inheritor of someone who passes away, you'll need to get in touch with their pension providers to let them know about the death and find out what happens next.

If the person was already receiving pension benefits, you will need to inform the pension scheme as soon as possible. Failing to do so may mean you’ll have to pay back any pension and possibly interest on these payments received after the date of their death.

When it comes to the State Pensions, unfortunately there aren’t any death benefits so there’s nothing to pass on to beneficiaries.

However, if someone was receiving a State Pension when they died, you will need to call the Pension Service(www.gov.uk opens in a new tab) on 0800 731 0469 and ask for the Bereavement Service to inform them of the death. Again, you may have to give some money back if a payment has been made to the deceased person after they died and before you managed to let the department know.

If the deceased also had a workplace or personal pension, or both, then contact either the scheme administrator/trustees or the pension provider for every pension scheme the deceased had.

If they were still in employment when they died, their employer may have contacted the scheme already, but it's always best to check and make sure.

Once you’ve reported the death to the pension providers, they'll write to you to tell you what happens next. But remember, you can always check with them to find out whether you're entitled to receive any pension benefits or a lump sum.

If you know the deceased had a pension but you can’t find the documents yourself, get in touch with the Pensions Tracing Service(www.gov.uk opens in a new tab) – they can help to find any pensions that had somehow gone astray.

The website Gretel.co.uk(www.gretel.co.uk opens in a new tab) also offers a very helpful, free pensions tracing service. They can also help to trace forgotten ISAs, savings accounts and other financial products that your deceased relative may have had.

Jasmine Birtles is a TV financial expert and runs the self-help money website MoneyMagpie.com(www.moneymagpie.com opens in a new tab)