What happens to a pension when someone dies?
When you die your spouse, civil partner or beneficiaries may be able to inherit your pension. The pension trustees will decide who the pension passes to, but they will consider your expression of wish form.
The exact rules for pension death benefits will vary depending on the type of pension you have and your age on death.
How do pensions work after death?
The Executor or Personal Representative responsible for administering the estate will need to contact each pension provider or pension administrator (if it is an occupational pension scheme) to inform them that the member has died with a view to establishing: the value of the plan on the date of death; whether the plan has been fully crystallised; whether the plan had received a transfer value from another pension arrangement within the last two years; details of any nominations; and whether there have been any excessively large contributions made in the two years prior to death.
In this article we will focus on the duties of the personal representative, issues around pension death benefits and ensuring that any taxes due are paid to HM Revenue and Customs.
Taking on the role of personal representative means you have certain responsibilities in dealing with the estate of the person who has died and you are potentially opening yourself up to liabilities if you do not deal with the estate correctly.
Being a personal representative is a role for life, as any claims against the estate that happen in the future will have to be dealt with by you.
To help you we have created a step by step guide for you to consider.
A Step by Step Guide
Step 1 – Gather the information
As the personal representative administering the estate, once you have identified all of the pension plans held by the deceased your first action will be to contact each pension provider, or pension administrator if it is an occupational pension scheme, to inform them that the member has died. At that time you will want to establish the following details:
- The value of the plan on the date of death
- Has the plan been fully crystallised?
- Whether the plan had received a transfer value from another pension arrangement in the last two years
- Details of any nominations made by the member before they died
- Have there been any excessively large contributions made in the two years prior to death?
The reasons you will need this information are explained in more detail below:
One of your core duties is to assess whether the member has accumulated pension benefits during their Lifetime that exceed the Lifetime Allowance. The Lifetime Allowance is the maximum tax efficient fund that you can build up without having to pay a tax charge – the Lifetime Allowance Excess Charge.
What does pension crystallisation mean?
When pension scheme members take benefits from their pension before they die, it’s referred to as pension crystallisation.
If the member had taken benefits from their pension plan before they died (crystallised their pension funds) those plans will have already been tested against the Lifetime Allowance and will not need to be assessed again as part of the estate administration.
At this point it is probably worth noting that there is also no Lifetime Allowance test when death occurs after age 75 as the final Lifetime Allowance test takes place at age 75.
Has the pension plan received a transfer in the last two years?
Generally, pension plans do not form part of your estate when you die and are free from Inheritance tax. However, if the member transferred money between pension funds in the two years prior to their death and were in poor health at the time of the transfer with a reasonable expectancy that they may not live for a period of two years following transfer, H M Revenue and Customs may include the pension plans in the assessable estate for Inheritance Tax.
As personal representative, applying for Probate, you will be asked this question on the probate application forms.
Details of any nominations made by the member
Typically, pension providers ask plan holders to nominate one or more beneficiaries when they take out a policy, so there is no question as to who they would like to receive the benefits when they die.
It is worth noting that the provider is not bound by the nomination, and can consider payments to other individuals, particularly if there is no surviving spouse or financial dependant.
As the personal representative of the estate you may be asked if there are other people who should be considered as a potential beneficiary of the pension funds by the pension provider.
Defined Benefit Occupational Pension Schemes operate slightly differently as the rules of the scheme will often determine who is eligible to receive benefits when the scheme member dies.
Step 2 – Complete a Lifetime Allowance Assessment
As we have already mentioned, the personal representatives are responsible for establishing whether the Lifetime Allowance of the deceased has been exceeded and you will need to carry out this assessment.
Depending on the number and types of pension plans held this can be quite a daunting task and you may need to take advice from a qualified independent financial advice firm, such as The Private Office, to help you with this task. You can get in touch with us today and arrange a free consultation.
Step 3 – Inform the beneficiaries of any taxes due
If the Lifetime Allowance assessment of any uncrystallised pension funds or death in service benefits provided by the employer (if applicable) shows that any remaining Lifetime Allowance has been exceeded at the time of death, it is the personal representatives duty to inform the beneficiaries that they will have a Lifetime Allowance Excess Charge to pay from the inherited pension funds.
The pension provider will pay the full amount of the inherited pension fund directly to the beneficiaries who are then personally responsible for paying this lifetime allowance excess charge.
The amount of tax due will depend on how the pension fund money is received. If the beneficiaries decide to take a lump sum, the tax charge will be 55% of the excess fund. If the excess fund is used to provide an income, the tax charge reduces to 25% but the income paid from that part of the fund will suffer marginal rate tax too.
You can find more information on how benefits can be drawn from a pension on our pension page.
Step 4 – Be aware of time
Under the current rules a beneficiary inheriting a pension fund can usually access the money in that plan free of income tax and inheritance tax if the plan-holder dies before their 75th birthday and there was no transfer in poor health in the two years before death.
However, for the benefits to remain tax free for the beneficiaries, payment of the funds has to be made by the pension plan/scheme administrator within two years of death – either into a drawdown arrangement or as a lump sum death benefit paid to the beneficiaries.
If the two year window is missed payments to the beneficiary will no longer be tax free, and they will have to pay marginal rate income tax on any benefits they receive.
As the personal representative you are not directly responsible for making sure that the beneficiaries provide this information to the pension plan or scheme administrator but the beneficiaries may rely on you to tell them this type of information – could this fall into duty of care?
If you think the person who has died may have had other pension funds, possibly linked to an old employer, then you can also use the Pension Tracing Service to locate information about them. Details can be found at www.gov.uk/find-pension-contact-details.
If you believe that the deceased may have been eligible for Lifetime Allowance protection, but did not register for this before they died, then it is possible for the personal representatives to make a posthumous application to HM Revenue and Customs.
With so many different types of pension arrangements in existence, all with their own rules, and the complexities of the Lifetime Allowance it can be extremely challenging for a personal representative to be confident that they have taken all of the appropriate steps needed. Why not let us help you?
The Financial Conduct Authority does not regulate Tax Advice or Estate Planning.
We have decades of experience in helping people manage their pension funds, and are here to help.
If you would like more information on the broader duties falling to you as a personal representative get in touch today.