Dying too soon, living too long – the pension conundrum

This may seem a morbid question, but when it comes to your pension, is there ever an optimum time to “shuffle off this mortal coil”?

Wealth Briefing

There’s no easy answer to such an emotive question. What’s important is that regardless of which type of pension you have – defined benefit (DB) or defined contribution (DC) – and whatever stage you are at – pre or post retirement – you understand what benefits you and your loved ones are entitled to.

It’s an age thing

Unless you’re a tortured rock star or artist, you are unlikely to aspire to die young. When we first join a pension scheme, we assume we will be around to spend the pension it pays out. And with life expectancy consistently rising, chances are we will be. However, in reality, some of us won’t make it to retirement.

This raises questions about what happens to your pension after you die. You might have dependents who would be impacted by your early death, perhaps young children. How will they be supported if you’re not here? Of course, living too long comes with its unique challenges too. Will your pension sustain you through retirement, which could be as much as 40+ years? Will you be able to afford healthcare if you need it? Can you leave a legacy?

The answers will depend on the assets you’ve accumulated and which type(s) of pension you have.

Defined benefit – a dead cert?

DB pensions are often referred to as ‘gold plated’, promising to pay a guaranteed, regular income for life. This may provide peace of mind that your bills will be paid in old age and is one reason why the majority of those lucky enough to have a DB pension are best advised to keep it.

So what happens to your DB pension when you die? If you are married, part of your guaranteed income normally continues to be paid to your spouse or civil partner. There may be pensions for your children under 23 too or those still financially reliant on you, depending on your scheme’s rules. And if you were still working for the DB employer, a lump-sum death benefit may also be paid. This can leave your loved ones well provided for.

If you’re unsure, check with your pension provider to find out whether your DB scheme offers these and other potential benefits.

Defined contribution – more freedom but at what price?

And so on to DC death benefits. The new UK pension legislation that came into force in 2015 made DC pension wealth more inheritable. Indeed, the changes to death benefits have been cited as one reason why some DB members, wealthy enough not to be concerned about paying the bills in old age, might consider giving up their ‘gold-plated’ DB pension and transferring the value to a modern DC scheme. Nonetheless DB transfers remain a contentious issue due to concerns over poor advice. On death, under most modern, flexible DC pensions (such as SIPPs) any money left in your pot (including ‘drawdown’ pots) can normally be passed on. If you die before 75, the whole amount would normally be tax free.

New UK pension legislation that came into force in 2015 opened up many more options for retirees

The rules on who can inherit your pension pot have been relaxed too so, in most cases, you can leave a tax-efficient legacy to your children, grandchildren or any nominated individual, not just your spouse or civil partner. In turn, your beneficiaries can pass what remains of your original pension pot to the next generation when they die. Remember though, these options may only be available if you’ve made the right death benefit nomination and kept it up to date. If you die after buying an annuity, what, if anything, your dependents receive will depend on your annuity type. In some cases, your annuity could end when you die, while some may pay out any unused guaranteed income to your dependent(s) in a lump sum, which would be subject to tax. Similarly, many older DC pensions don’t offer the new flexible death benefits, so your loved ones might not have the options you’d hoped. And some very old-fashioned DC pensions may only pay back your own contributions (possibly without interest!) if you die before retirement.

Not the be all and end all

When it comes to retirement, there are more considerations than just death benefits, the most important of which is that you have enough to live on. Therefore, it makes sense to seek advice on all aspects of pension and estate planning, including the associated and sometimes very complex risks. In fact, it’s a legal requirement for transferring DB benefits worth more than £30,000.

Modern DC pensions can provide flexibility over retirement income and inheritance, but you shoulder all the investment risk of making that income last. Furthermore, consider if you are in the right DC pension to deliver the legacy you envisaged.

A DB pension, meanwhile, offers a ‘guaranteed income for life’, and normally guaranteed pensions for your surviving spouse or dependants, with your provider carrying all the investment risk. Indeed, the Financial Conduct Authority (FCA) has stated that “Defined benefit pensions, and other safeguarded benefits such as guarantees, are valuable so most consumers will be best advised to keep them.”

Living in the present

Ultimately, what you do with your pension is a huge decision, so make sure you don’t live to regret it. Sorting it out now, means you can get on with living in the moment.

Laws and taxes may change in the future. The information here is based on our understanding in February 2018. Your personal circumstances can also have an impact on tax treatment. A DC (personal) pension is an investment; its value can go up and down and may be worth less than you paid in. Transferring from DB to DC is not right for most people as valuable guarantees will be lost.

Control the things you can

What can you do now to make it easier on your loved ones when you’re gone?

  1. Review your pension to check if it’s right for you. If not, seek advice on whether there’s a better option for you in your circumstances.
  2. Make a will and revisit it regularly – especially if your family structure is complex.
  3. Make your intentions clear.
  4. Keep your pension nominations up-to-date.
  5. Think about gifting some of your money (after seven years, gifts do not incur inheritance tax – and some will fall outside the IHT net sooner).
  6. Consider appointing a financial power of attorney.
  7. Seek advice – there’s no substitute for pension and estate planning from a trusted adviser.

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