A pension is typically the second largest asset that someone owns (after the family home).
However, they often get overlooked when people think about passing on their wealth, as they fall outside of an estate for inheritance tax (IHT) purposes.
Understanding pensions and what to do when you inherit one can be tricky too, with various options and considerations depending on the type of pension and your circumstances.
This blog post aims to guide you through the key steps and choices you might face when dealing with an inherited pension.
What happens when you inherit a pension?
If you are a nominated beneficiary of a pension, the scheme administrator will write to you to let you know what your options are for accessing the money.
Unlike other assets you can inherit, executors – or family and friends – aren’t involved in the decision making process.
The scheme administrator will review key information, including an expression of wishes, to help decide who the pension is left to.
Wills and the laws of intestacy will also be taken into consideration if the key information that they have isn’t enough.
How to Claim Pension Benefits as a Beneficiary
Reaching out to the pension administrator will help you determine if you are eligible for it to be transferred to you or not.
Be prepared to gather the necessary legal information to move things forward.
You will need the deceased’s National Insurance number, full legal name, birthdate, and date of his death.
You will also need some legal documentation of yourself to validate your identity.
One of the things you will be expected to do is fill out a lot of paperwork.
Keep track of all the important documents as you work on the paperwork and hold on to everything you get back from the pension plan administrator.
Understanding the Type of Pension
There are two main types of pension and each has its own characteristics.
1. Defined Benefit Pension
A defined benefits pension is provided by an employer.
The benefits accrued are based on the employee’s salary and the number of years they worked for the company.
These pensions are typically more strict about whom they can be transferred to.
They usually only allow the following types of beneficiaries:
- Spouse
- Civil partner
- Dependant child
2. Defined Contribution Pension
These pensions are built up through contributions from the individual and/or their employer.
The value of a defined benefit pension depends on how much has been paid in and how the investments have performed.
If you inherit this type of pension, you typically have several options for accessing the funds.
Options for Accessing Inherited Pensions
Once all the paperwork is done, you should be able to transfer the pension (or your share of it) into your ownership.
You will have a choice of how you want it to be distributed.
1. Take a Lump Sum
Some pensions allow beneficiaries to take a lump sum.
This might be appealing for immediate financial needs but consider the long-term tax implications and financial stability.
2. Annuity or Regular Income
Alternatively, you might be able to receive regular payments, similar to an annuity.
This can provide a steady income stream, but it’s important to understand the terms and conditions.
3. Transfer the Pension
Transferring the pension into a different scheme, such as a personal pension, is another option.
This could offer more flexibility in how the money is invested and withdrawn but comes with its own set of rules and potential risks.
This can be a wise choice if you’re looking to consolidate your pensions or if your own pension offers better benefits.
Tax Considerations
As mentioned in the introduction, a pension typically sits outside of a person’s estate for IHT purposes.
Anything left in the deceased’s pension can be paid to the beneficiaries when they die – whether that’s as a lump sum or at regular intervals.
In terms of tax rules:
If the deceased died before they’re 75 – this money is generally tax-free.
If the deceased died after the age of 75 – any money paid out will be subject to tax based on your individual tax position as the beneficiary.
However, if you are tax resident outside the UK, you will need to consider income tax implications in your current country of residence as well as the UK.
Consulting with a local tax advisor is recommended to understand your specific situation.
Seek Professional Advice
Given the complexity and importance of pension inheritance, it’s advisable to seek professional financial advice.
A financial advisor can help you understand the specifics of the pension you’ve inherited, the tax implications, and the best options for your circumstances.
The Bottom Line
Inheriting a pension can present an array of choices.
It’s important to understand the type of pension, assess your options for accessing the funds, and be aware of the tax implications.
Remember, professional advice is key to making informed decisions that align with your financial goals and needs.
FAQs
Q: Can I inherit a pension if I’m not a spouse or civil partner?
A: Yes, but it depends on the pension scheme’s rules. Some allow for nominated beneficiaries.
Q: Is there a time limit for decisions about an inherited pension?
A: Tax may be payable if the beneficiary is paid more than two years after the provider is informed of the saver’s death, even if they were under the age of 75.
Q: What happens to the pension I have inherited when I die?
A: If you inherit a defined contribution pot you can nominate someone to get any money you do not use before your death.
Q: What happens if no beneficiaries have been nominated for a pension?
A: If no beneficiaries have been nominated, administrators could consider any dependents or beneficiaries of a will. However, this may not reflect what the deceased intended for their pension funds.
Q: What happens when I inherit a QROPS?
A: A QROPS is not subject to UK Inheritance Tax. However, if you are not UK resident, you will have to comply with the IHT rules in your country of residence.
This post provides an overview and is not exhaustive. Pension laws and regulations can change, and individual circumstances can significantly affect the best course of action. Always seek up-to-date professional advice when dealing with an inherited pension.
Further Reading
