Death After Pension Benefits

Death After Pension Benefits- Annuity, Drawdown, Inheritance Tax – Pensionfinder

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    Death After Pension Benefits- Annuity, Drawdown, Inheritance Tax

    DEath after Pension BenefitsAnnuities and income drawdown have some significant differences but death benefits are possibly the most apparent. Please note that the government are considering the implementation of major changes with could affect the information you read below in future. Each tax situation will change depending on the person’s financial circumstances. There are numerous types of death benefits and the whole process can be confusing. Contact an independent financial advisor for more information if you are uncertain about anything.

    Annuities And Death Benefits

    Annuities have a trio of death benefits options to choose from. Once your choice has been made, it is final and cannot be altered.

    Option number one is to choose your spouse’s pension at the beginning. This will mean they receive payments after your death. The starting income depends on how high you set the spouse’s pension level. A high level equals a low starting point. This option can be seen as something of a risk because the money will be wasted should they die before you. On the other hand, should they outlive you, there is the possibility that they will be short of income if you do not invest. Contracted out pensions take care of this issue because they force you to provide for your spouse if you die. Under their conditions, your spouse should receive half the annuity’s value until they die.

    Another option is a guaranteed payment period of up to and including 10 years which begins the moment you start receiving annuity income. This option ensures that your income continues to get paid for the next decade even if you die within that time. Those who survive the 10 year period in this example will continue to receive annuity payments until their death. This guaranteed period means your starting income will be lower than usual with contracted out pensions only allowing a maximum guarantee period of 5 years.

    The third option is that of a value protected annuity. This means that the value of your annuity minus the payments already paid will be given to a beneficiary upon your death with a 35% tax charge added. Benefits given on a discretionary basis will not be charged with inheritance tax. Once you reach the age of 75, it is impossible to use this benefit.

    Unsecured Pension

    Income drawdown offers better death benefits than annuities on average which is one of the main reasons why people choose this option. If you die while still in income drawdown, you can still ensure that the rest of your pension money is put to good use.

    • Your dependent can simply continue receiving payments from income drawdown as normal or the ASP with this money being treated as taxable income.
    • Your fund can be used to purchase an annuity by your dependent with the payments once again treated as taxable income.
    • Whomever you choose to be the beneficiary will be able to withdraw the entire value of the fund or a percentage with a tax charge of 35% applicable.

    With a contracted out pension, you will have to make sure your partner/spouse receives an income from your pension in the form of an ASP/income drawdown or annuity. A beneficiary will receive the money if you have no spouse but like in the example above, they will be charged 35% tax.

    Alternatively Secured Pension

    The ASP is available once you turn 75 and is more flexible than an annuity though not as filled with options as income drawdown. 

    • It is necessary to use an ASP to give a stream of income to your dependent or spouse.
    • You could achieve this by placing money into an income drawdown plan if the beneficiary is younger than 75 or else by purchasing an annuity. Once your recipient turns 75, the income drawdown option is no longer available with the ASP used instead.
    • Those who have no spouse or dependents will have their money paid into a charity free from Inheritance Tax as these are known as authorised payments.
    • If you have a contracted out pension (which stipulates that you must provide your spouse with a source of income) but have no spouse, the fund will be paid to a beneficiary of your choosing. If none is named, the money goes directly to your estate. Due to Protected Rights legislation, we are all legally obliged to issue this payment but if it is not an authorised payment, a massive tax charge of 70% could be applied.

    Phased Retirement

    If you have several different forms of death benefits or pension funds, they may each have their own separate set of rules which means that they would all be treated individually. An example of this would be purchasing an annuity while also being in income drawdown with other funds available that you have yet to take benefits from.

    Inheritance Tax

    This tax is placed on your estate once you die and is usually charged at a rate of 40% over the inheritance tax free allowance. There is usually no inheritance tax charged on the lump sum left by you if you die while in income drawdown. However, there is a tax charge of 35% which is separate from inheritance tax.

    There should also be no inheritance tax charged if you die in ASP with the fund available to a dependent or spouse. They could go into income drawdown with this money provided they are under 75. If your spouse or dependent dies before they reach 75, the fund could then be crippled by the 35% tax charge as well as inheritance tax. Although cash paid to charities from an ASP is free from tax, paying a charity from income drawdown carries the 35% tax charge.

    The above is but a summary of the current tax regulations with regards to death benefits but this situation could change at any time. Be vigilant and make sure you keep up to date. If in doubt, play it safe and talk to an independent financial expert.

    Tax-Free Cash

    Death benefits can change dramatically if you have taken your benefits. You cannot withdraw tax-free cash if you have not taken your benefits. You can achieve this by going into income drawdown and not taking an income. Dying in income drawdown means your fund will be hit with a 35% tax charge should a beneficiary choose to take the money in one lump sum. If you did not take tax-free cash or income you will not have to pay any tax if you elect to pass on the value of the pension to beneficiaries upon your death.