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What happens to my pension when I die?

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For many people, the pension they have saved for throughout their working lives is their biggest single asset. Knowing what happens to your pension when you die can help set your mind at ease.

Inheritance tax and pensions

As Benjamin Franklin once famously wrote, there are two certainties in life – death and taxes. And until recently, tax on inherited pensions was doubly certain. But Chancellor George Osborne recently announced sweeping changes to the way pension savings are to be treated for tax purposes, as part of the wide-ranging pension reforms coming in from April.

So what happens to your pension after you die? Previously, if you had drawn an income or taken a lump sum from your pension (a process known as ‘crystalising’ in technical pensions language), or you were aged over 75 and hadn’t used your pension pot to purchase an annuity, your remaining fund could be passed to your beneficiaries – but only after incurring a 55% tax charge.

From April, anyone who dies below the age of 75 will be able to pass on their Defined Contribution pension tax free. The money can be taken out as either a one-off lump sum or drawn as ad hoc payments.

What happens to your pension if you die aged 75 or over? You will be able to leave your pension to a beneficiary, who will pay their marginal rate of income tax to access the pot. If the beneficiary takes the pension as a lump sum, it will be liable for a flat-rate tax charge of 45%, although the government hopes to reduce this to the marginal rate by 2016-17.

Dependents’ pensions

If you are approaching retirement and plan to buy an annuity, you may have the option of buying a ‘joint life’ or ‘dependents’ annuity’.

These continue to pay out to your spouse, civil partner or dependent children after you die, and you can choose the amount they will get – usually 50% or 2/3 of your monthly income, although up to 100% may be available.

However, you should bear in mind that because the annuity will pay out for longer than your own lifespan, choosing a joint life annuity will reduce the monthly amount you receive. In some cases, dependent’s pensions can pay out a lot longer than may have been intended - as of October 2014, there was still a US Veterans’ pension being paid to a child of a soldier who fought in the American Civil War, which ended in 1865.

This article has been commissioned by retiresavvy and any opinions voiced are the author's own.

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