Plan what will happen to your pension when you die
Pension death benefits is not the cheeriest of topics, but it is a crucial part of pension planning. In defined contribution schemes there’s an enormous amount of flexibility and the options can be extremely tax efficient.
However, the downside is that the rules can also be very complex in certain situations, which could leave your beneficiaries (the people chosen to receive your death benefits) with fewer options or more tax to pay.
The good news is that there are two simple things you can do to help ensure that you don’t get caught out.
Check the options offered by your pension provider
The rules allow three options for beneficiaries: take the funds as a lump sum payment, keep the funds in a pension in order to draw flexible income (beneficiaries’ drawdown) or use the funds to purchase an annuity (a regular income normally payable for life). All pensions will offer the lump sum option, but not all will offer access to the other two.
Annuities for beneficiaries aren’t typically popular, but beneficiaries’ drawdown is often the most flexible and tax efficient option under the current rules – so the fact that it isn’t always available is a key consideration.
Once a beneficiary is in drawdown, they can transfer the funds to other providers in the same way that you can normally transfer your own pension benefits.
However, the catch is that the provider holding the pension funds when a person dies has to be able to put it into drawdown for the beneficiary in the first place. Unfortunately there’s no getting around this restriction, so it’s important to check that your pension provider offers beneficiaries’ drawdown if you want it to be available for your beneficiaries.
Check and update your expression of wishes
An expression of wishes is a document which tells your pension provider who you would like as your beneficiaries. Your provider isn’t normally obliged to follow your wishes, but this shouldn’t be a cause for concern: the provider will only go against your request if there’s a good reason to do so. Your provider having ultimate discretion to choose the beneficiaries offers you two key benefits:
- It’s part of the arrangement which should mean the death benefits aren’t considered for inheritance tax purposes
- It allows the flexibility for different beneficiaries to be chosen if needed – for example, if your named beneficiary unexpectedly turns down the funds.
Most issues which arise in relation to paying death benefits are either caused by the deceased not having an expression of wishes in place, or having one which is no longer appropriate because his or her circumstances have changed.
Pension providers have the discretion to assess the situation and choose the most appropriate beneficiaries. However, due to a rather frustrating restriction in the rules, in these circumstances the chosen beneficiaries may only be able to take a lump sum payment, even if the provider offers drawdown.
The best way to avoid this is to keep your expression of wishes up to date as your circumstances change, to minimise the risk of the provider needing to consider other beneficiaries. Although it’s a difficult conversation, it can also help to discuss your decision with your family, so that they understand your wishes and there are no surprises for anyone when the time comes.
Keeping on top of these two things will greatly reduce the chances of your beneficiaries being left short of options or paying more tax than necessary. It will also help to make the process of paying your beneficiaries as smooth as possible at an impossibly difficult time.
Jessica List is pension technical manager at Curtis Banks