What happens to my Defined Benefit pension when I die?
The first thing to clearly state is that every scheme has its own rules and it is in each individuals best interest to know exactly what the rules of their scheme are. However, most defined benefit pensions are relatively similar when it comes to the rules regarding survivor benefits.
Typically, defined benefit schemes have provisions for a spouse to receive benefits from the scheme, in the event the member of the scheme dies. Most will also have provisions for children to be eligible to receive some benefits, although this usually depends on the age of the children.
One important thing to note is that many schemes will only honour the spousal benefit if the member and their beneficiary are legally married. There have been instances where long term partners have not been able to receive benefits upon the passing of the scheme member, due to not being legally married.
Most schemes have an arrangement that in the event of the members death, the spouse will be entitled to a percentage of the proposed annual income the member would have received. This is usually around 50% but in some cases, this can go up to as much as 65%. In many schemes this comes with a ‘guaranteed period’, after which there is no guarantee the scheme will continue paying the survivor benefit.
When will you receive your survivor’s benefit?
If the member was already receiving the pension when they passed, then this would simply continue to be paid, just at the reduced amount.
If your spouse dies before retirement, you may have a choice. It may be possible to choose for the plan to start making payments on the date your spouse would have reached early retirement age and receive a smaller spouse benefit. Or, you can choose to wait until the date your spouse would have reached the plan’s definition of normal retirement age in order to receive the full spousal retirement benefit.
The rules around this can also change depending on whether the member is still active within the scheme (working for the company at the time of death) or a deferred member.
Many schemes may also pay benefits from the time of death, usually as a lump sum calculated from the final salary of the member. However, in order for this to happen in a tax efficient manner, the scheme is required to pay out within 2 years of the members death. Notifying the scheme of the members death as soon as possible is therefore a wise thing to do.
The lump sum would be free from tax for members who were under the age of 75 at the date of death, although, If the lump sum was in excess of the LTA, a tax charge of 55% is levied on the lump sum paid over the LTA. (Read more about Life Time Allowance here).
For members over the age of 75, the money will be taxed in the hands of the recipient at their marginal rate. Remember that at age 75 a crystallisation event will have occurred.
What happens in the case of divorce?
If you are a divorced spouse, you may receive survivor rights if that is provided for as part of the division of pension benefits during the divorce proceedings.
For children to receive any benefits from the scheme they usually need to be below the age of 18. Some schemes push this age up as far as 23, but this usually only applies if the child is in full time education.
What other options are there?
One of the most common reasons people transfer out of their defined benefit schemes is to increase the flexibility of their pension pot, especially with regards to inheritance.
If a defined benefit pension is transferred into a private pension such as a SIPP or a QROPS, it would no longer be tied to the rules of the defined benefit scheme. This means that in the event the pension owner dies, the spouse can receive the full benefit of that pension. It would be the spouse’s decision as to whether they leave it invested, take what they need from it as and when, or take the full value as a lump sum. (Read more about death taxes and SIPPS here).
Moreover, as it becomes a private pension, benefits that can be left to children are not restricted or dependent on age. The pension holder can nominate beneficiaries as they wish.
We would recommend that anyone who has a defined benefit pension in the U.K fully reviews the rules of their scheme with regards to inheritance.
If you would like one of our advisors to look into your scheme for you and complete a full report to highlight your existing benefits and potential options, please get in touch with us today.