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.
Most pension schemes allow you to leave your pension pot to another person.
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.
, 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.
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.
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That said, pension schemes aren't bound by your nomination of benefits letter - for example, if they think it might be out of date, or you've disinherited one of your dependents in favour of a stranger.
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.
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:
|Inheritance||Your age when you die||Tax your beneficiary will pay|
|Unused cash taken from your pot||Any age||Inheritance tax if applicable|
|Any untouched pension left in your pot||Under 75||Zero, if they take it within 2 years|
|Over 75||Income tax at their normal rate|
|Money from a new drawdown fund (post 6 April 2015)||Under 75||Zero|
|Over 75||Income tax|
|Money from an old drawdown fund (pre 6 April 2015)||Under 75||Income tax|
|Over 75||Income tax|
Generally, pension sums won't be liable for . 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.
The state pension is made up of two parts - the basic state pension and any additional state pension you may have built up.
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 before||5 October 1942 or before||100%|
|6 October 1937 to 5 October 1939||6 October 1942 to 5 October 1944||90%|
|6 October 1939 to 5 October 1941||6 October 1944 to 5 October 1946||80%|
|6 October 1941 to 5 October 1943||6 October 1946 to 5 October 1948||70%|
|6 October 1943 to 5 October 1945||6 October 1948 to 6 July 1950||60%|
|6 October 1945 and after||6 July 1950 and after||50%|
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.