The AJ Bell survey showed only 4% could identify how it would be taxed. With nine million people contributing to personal pensions each year, that is 8.4 million consumers who don’t understand the rules.

The provider has written to Philip Hammond, Chancellor of the Exchequer, calling for the discretion providers currently have around how pension death benefits are distributed to be removed, with all pension death benefits remaining free of inheritance tax (IHT).

Andy Bell, chief executive at AJ Bell, said: “The way pension death benefits are taxed is one of the most generous outcomes of the pension freedoms but this is lost on the vast majority of people. Most of them also assume the funds will automatically go to their nominated beneficiary, without realising that their pension provider currently has discretion to alter that. In the new era of pension freedoms this control should remain with the pension holder, not the pension provider.”

Who benefits?

Of those surveyed by AJ Bell, half (51%) assumed their pension would automatically go to the person they have nominated as the beneficiary of their pension. 14% think it will form part of their estate and be distributed as per their will, and a quarter (25%) admitted they didn’t know.

When it comes to how their pension will be taxed upon their death, only 4% of people questioned correctly identified that it would be tax-free if they die before age 75 and subject to income tax of the beneficiary if they die post 75. A majority (58%) admitted outright that they didn’t know while some others thought it would be subject to the main forms of taxation such as income tax (10%) or IHT (14%).

Additionally, only one in five British adults with personal pensions (18%) have nominated who they would like to receive their pension on death within the last three years.  A third (32%) have never nominated a beneficiary and another third (35%) nominated their beneficiary over five years ago.

Discretion and Inheritance Tax

AJ Bell said the fact that pension providers have discretion over who receives death benefits means they can provide people with an IHT benefit. However, most people don’t understand the process and therefore don’t know who will receive their pension death benefits or how they will be taxed.  Pension providers are obliged to consider all potential beneficiaries but family circumstances change frequently and people don’t update their nominated beneficiaries regularly.

Bell added: “A relatively straightforward change to the rules could greatly simplify this area of the pension system without being a huge cost to the government. It is clear that the current rules are designed so that pensions are not liable to inheritance tax in the vast majority of cases and so formalising that outcome in all cases is not a difficult step for the government to take. It is an oddity that the provider having discretion over the payments is a condition of this tax treatment and feels out of place in today’s world of pension freedom and choice.”

YourMoney.com view

Your pension fund is often your greatest single asset outside of your main home. As such, it is good to establish how it would be distributed on your death. Although pension providers have discretion, in most cases it will be distributed in line with your statement of wishes – held with your pension provider, so make sure this is up-to-date.