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Updated: 20 Mar 2018

Do you know who will inherit your pension pot?

Understand what happens to your pension after you die

Around 750,000 people in the UK are at risk of passing their pension to the wrong person, new research has revealed. But do you understand the rules for inheriting a pension pot?

When you die, your pension funds may be inherited by your loved ones. But who inherits, and how much, is governed by complex rules.

Which? explains what happens to your pension after you die and what you need to do to put your affairs in order.

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What happens to my pension pot when I die?

Most pension schemes allow you to leave your pension pot to another person.

If you're in a defined contribution pension scheme, any money left in your pot will be passed to someone you've nominated - and it doesn't necessarily have to be a spouse or dependent.

Generally, the money will be paid out as a lump sum, but some schemes may give beneficiaries the option to keep the money invested and receive a drawdown pension.

Defined benefit pensions, on the other hand, can usually only be left to a dependent of the person who died - so a spouse, civil partner or child under 23. The scheme may allow it to be paid to someone else, but it could be taxed by up to 55% as an unauthorised payment.

Who inherits your pension pot?

You can nominate who you'd like to receive your pension pot in an 'expression of will' letter. Your pension scheme provider will use this as guidance to decide who your pot should go to.

This means if you divorce and re-marry - like 1.3 million other Brits aged between 55 and 64 - your new spouse may not stand to inherit unless you update your paperwork. Insurer Royal London estimates that up to 750,000 people in the UK could potentially be caught out.

It's especially important to be on top of your paperwork if you've changed jobs, and have a number of company pension schemes to your name.

If you don't sign a letter, or the pension scheme is uncertain what your wishes were, they might consult your will or your executor to better understand what you might have wanted.

That said, pension schemes aren't bound by your nomination of benefits letter - for example, if they think it might be out of date, or you've disinherited one of your dependents in favour of a stranger.

Will my beneficiaries pay tax on my pension?

If you have a defined contribution pension, you can pass it onto anyone you wish. But whether or not the beneficiaries of this choice will pay tax depends on the age at which you die, and their personal tax situation.

If you're under 75 when you die, your beneficiaries will inherit any lump sums tax-free, provided they claim it within two years.

But if you're over 75, they'll need to pay income tax at their normal rate - in the current tax year, that could be 20%, 40% or 45%.

That said, inheriting a lump sum from a pension could push your heirs into a higher tax bracket, as their overall amount of income would be increasing in the tax year they take the lump sum. They could keep their tax bill low by taking smaller lump sums over a number of years to avoid this.

The rules are explained below:

InheritanceYour age when you dieTax your beneficiary will pay
Unused cash taken from your potAny ageInheritance tax if applicable
Any untouched pension left in your potUnder 75Zero, if they take it within 2 years
Over 75Income tax at their normal rate
Money from a new drawdown fund (post 6 April 2015)Under 75Zero
Over 75Income tax
Money from an old drawdown fund (pre 6 April 2015)Under 75Income tax
Over 75Income tax

Generally, pension sums won't be liable for inheritance tax. The exception is if you've taken a lump sum, and still have it sitting within your savings or bank account - this will then form part of your estate and be subject to the inheritance tax rules, which could mean your beneficiaries pay 40% tax.

Previously, a tax of 55% was charged on inherited pensions. This was abolished as of April 2015.

Can I pass on an annuity?

If you've swapped your pension savings for a regular income by buying anannuity, you might be able to leave it to a nominated person. But it will depend on the type of annuity you've bought.

  • Single life annuity: when you die, your payments will stop, and any funds not paid out as income will stay with the annuity provider
  • Joint annuity: your payments will continue to your beneficiary, but will stop once they die
  • Guaranteed period: if your annuity has a guaranteed period, it will continue to be paid out to your spouse until the end of that period, typically five or 10 years.
  • Capital protected annuity: your beneficiary can inherit a lump sum, minus any annuity payments you already received.

What happens to my state pension when I die?

The state pension is made up of two parts - the basic state pension and any additional state pension you may have built up.

  • If you qualified for the state pension before 6 April 2016, your final state pension amount will be a combination of these two amounts.
  • If you qualified for the state pension after 6 April 2016, there's a new 'single-tier' amount, currently £159.55. If what you would have got under the old system was higher, you'll get the bigger amount.

For those who got the state pension before 6 April 2016, between 100% and 50% of any additional state pension - not basic state pension - can be inherited by spouses and civil partners. This varies based by date of birth,as shown in the table below.

Deceased's date of birth (male)Deceased's date of birth (female)Maximum % of theiradditional state pension you can inherit
5 October 1937 or before5 October 1942 or before100%
6 October 1937 to 5 October 19396 October 1942 to 5 October 194490%
6 October 1939 to 5 October 19416 October 1944 to 5 October 194680%
6 October 1941 to 5 October 19436 October 1946 to 5 October 194870%
6 October 1943 to 5 October 19456 October 1948 to 6 July 195060%
6 October 1945 and after6 July 1950 and after50%
Source: Gov.uk

For those who qualified for the state pension after April 2016, half of any amount theyget above the new basic state pension of £159.55 (as part of any additional state pension they'd built up under the old system) can be inherited by a spouse or civil partner.

This article was updated on 5 March to clarify that the taxation of inherited pension does not depend on when the drawdown plan was taken out and that inheriting an uncrystallised pension does not affect the beneficiary's lifetime allowance.