When you die, all or some of your workplace pension could be passed on to your dependants – spouse, civil partner or other family members.

Thinking about death is something we’d rather avoid. But when it comes to a workplace pension, understanding the financial implications based on your circumstances can help when it comes to leaving a legacy for your loved ones.

Let’s look at what happens when you die, depending on the status of your workplace pension.

Types of workplace pension

There are two main types of workplace pension:

Defined contribution workplace pensions - this type of workplace pension allows you to build up a pension pot for retirement based on how much you and/or your employer contribute and how much this grows. There are no guarantees as to how much it will be worth at retirement.

Defined benefit workplace pensions – less common these days, this type of pension pays a guaranteed retirement income based on your salary and the length of time you were a member of your employer's pension scheme with contributions being made.

What happens to a Defined Contribution workplace pension when I die?

If you die with money left in your defined contribution pension, there are several options for passing on your workplace pension to your loved ones (known as beneficiaries).

When no money has been cashed in when you die

If you die before taking any money from your workplace pension, your beneficiaries can usually:

• withdraw all the money at once as a lump sum
• set up a guaranteed income (an annuity) with the proceeds or
• they may also be able to set up a flexible retirement income (pension drawdown).

Check with your workplace pension provider on the specific options available as they may vary from scheme to scheme.

When you’ve already started taking money when you die

If you’ve already cashed in some of your workplace pension when you die, your beneficiaries can usually:

• withdraw any remaining money at once as a lump sum
• set up a guaranteed income (an annuity) with the proceeds or
• they may also be able to set up a flexible retirement income (pension drawdown).

Check with your workplace pension provider on the specific options available as they may vary from scheme to scheme.

When you’ve already set up an annuity with your workplace pension funds

If you’ve purchased an annuity using funds from your workplace pension, the type of annuity will determine if your loved ones are entitled to any of it when you die.

An annuity pays a yearly guaranteed income until you die. If your annuity is a single life annuity, payments would stop and nobody else would be entitled to anything.

If you chose to include a guarantee period – a certain number of years that the annuity would pay out even if you died – then your nominated beneficiary would continue to receive payments until the guarantee period ends.

If you chose a joint-life annuity – with your spouse or civil partner, for example – they would continue to receive a proportion of your annuity income after your death.

What happens to a Defined Benefit workplace pension when I die?

If you die with a defined benefit workplace pension, the payments on death to any beneficiaries will depend on the rules of your pension provider.

The following people may be classed as dependants and therefore entitled to guaranteed annual payments:

• Spouse or civil partner
• Children under 23 and in full-time education
• Children of any age, if they’re mentally or physically handicapped
• Anyone who was financially reliant on you when you died

The amount a dependant can be paid will be based on the rules set by the workplace pension provider. They are specified in percentage terms based on the full value you would have received while alive. For example, if you would have been paid £10,000 a year in retirement and the pension provider specifies 50% dependant’s pension on death, then a dependant would get £5,000 a year.

A dependant may also be able to take a lump sum but is usually only allowed on small amounts.

Tax on your workplace pension when you die

The tax implications on your workplace pension depend on the type of pension and how old you are when you die.

When you die before your 75th birthday

Defined contribution pensions

The general rule is that if you die before you turn 75, any funds in your workplace pension can be passed to your beneficiaries tax-free.

The payment needs to be made within two years of the pension provider knowing about your death.

Your beneficiary may need to pay tax on the amount of your workplace pension that exceeds your pension lifetime allowance.

Defined benefit pensions

The general rule is that any dependant payments from a defined benefit workplace pension are subject to income tax, however old you are when you die.

Your dependants may be entitled to a tax-free lump sum payment if you die under 75 while still employed and are entitled to a death in service payment.

When you die after your 75th birthday

Defined contribution pensions

The general rule is that if you die after you turn 75, any funds in your workplace pension passed onto your beneficiaries will be subject to income tax.

Defined benefit pensions

As mentioned above, age is irrelevant as regular dependant payments are subject to income tax at whatever age you die.

Inheritance tax on workplace pensions

Many people wonder if their workplace pension will owe inheritance tax when they die.

One of the big benefits of pensions is that they are generally not subject to inheritance tax.

This is because pensions are considered outside of your estate as they are effectively held in trust and managed by your pension provider.

Inheritance tax might be due if you cashed in your workplace pension and didn’t spend it. So the cash in your bank account would then be considered part of your estate.

Ensuring your workplace pension is given to the right person / people

When your loved ones are coming to terms with your passing, the last thing they want is extra stress dealing with your finances.

When it comes to your workplace pension there are several things you can do to make things go as smoothly as possible:

• Add beneficiaries/dependants to your workplace pension and keep them updated if you need to change them
• Make a Will and specify your workplace pension/other pensions in it
• Set up Lasting Power of Attorneys to manage your finances in the event you can longer do it yourself
• Set up Guardians for any children that may need looking after should you pass away

The pension provider may ultimately still have discretion on who your workplace pension goes to, so having the above in order means there can be no misunderstanding regarding your wishes.

If you want to receive guidance and support for workplace pensions at your organisation, book a free Financial Wellbeing Lunch & Learn for your workplace.