It may not be the most amusing of topics, but it could well be one of the most important. A few weeks ago we considered what will happen to your money when you die; and the level of interest in the article showed that not only does this matter hugely, but people want to learn more.
So this week we’re considering what happens your pension when you die; after all, it’s most likely your biggest financial asset, worth more than your house or any other savings you may have, and it may be crucial in helping to provide for your family, and perhaps your spouse’s own retirement.
However, like everything to do with pensions, it's complicated, opaque, and full of jargon.
"Discussions typically only arise when the event arises," says John Lynch, partner with LCP Ireland.
But the death of a loved one is a difficult enough time, so make the time to have a chat now.
You’re in a work pension scheme
If you are a member of an occupational pension scheme through your employer, and you die while you are still working, your estate will be entitled to a "surrender value" of your pension, which means the value of both the employer and employee contributions made to the policy.
There are rules, however, as to how this can be paid out. Under Revenue rules, a lump-sum of up to four times your salary (including an average of bonuses), plus any contributions you have made (plus any investment gain on these contributions) to the fund, can be paid out in cash to the estate - this should take lump sum payments from previous jobs into account also. Where the value of the pension exceeds this, a spouse’s pension can be purchased with the remainder of the fund.
Watch out for the fine print too. Some pension schemes for example, won’t give your estate back employer contributions if you die within two years of joining the scheme.
If you have a number of pensions with different organisations, these will be paid out to your estate, whether or not you have transferred them to a buy-out-bond or consolidated them into your existing pension scheme.
For Fergus Collis, a senior actuary with LCP, it can make sense not to consolidate these different pensions.
“Having two to three pensions in different places can help, and provide with additional flexibility when you come to your retirement,” he says, noting that if you consolidated them all into your new scheme, you lose that flexibility.
“And it’s doesn’t necessarily change what death benefits are paid out,” he adds.
If you're in an old-style defined benefit (DB) scheme, your benefits are likely to be considerably higher should you die while in service.
Your spouse may be entitled to a widow/widower’s pension for example. Civil servants for example, are typically entitled to a spouse/civil partner’s pension of half the deceased’s payment. And there may also be a pension for dependent children up to the age of 21 or 23.
However, this approach isn't usual in a DC scheme, Tony Gilhawley of the Trusted Advisor Group notes.
“It’s normally just a lump sum,” he says.
It’s just another way in which our pension benefits have diminished as a result of the move from DB to DC schemes
“In an ideal world, everyone would be in a DB scheme,” says Gilhawley, “but new employers won’t set them up as they can’t afford them”.
What companies offering DC schemes could do, however, is set up a DB-style death-in-service benefit, which would offer the surviving family more substantial benefits.
“There is nothing stopping them from doing that,” says Lynch.
If you are separated or divorced, your former spouse may also have a claim on your pension, depending on the terms of your agreement, which will be paid out when you die.
Death-in-service
Quite aside from what happens to the accumulated pension pot itself, remember also that companies typically offer death-in-service benefits to employees who are members of the company pension scheme. But if you’re not in the pension scheme, you may not be entitled to death-in-service either, so it’s as good a reason as any to make sure you join your company’s scheme.
“You’re far better off joining the scheme,” says Gilhawley.
The amount companies offer differs, but is usually of the order of three to five times salary paid out in a lump-sum. You’ll find details on your death-in-service benefit on your annual pension statement.
For Collis, the payment is cheap for employers – and worth a lot to employees.
“The message I would say is that it’s a very valuable benefit to have, and it’s a very cheap benefit to provide from an employer’s point of view,”
For employees it’s also very valuable as it’s typically offered via a group scheme; this means that there is no individual underwriting so someone who may not be able to get life cover in the normal market due to health issues will be able to via this scheme.
Death in service obviously only applies where you are “in service” so being a member of previous pension schemes won’t result in additional life assurance payments.
Who the money goes to will depend on who you nominated on a nomination form. Remember, however, to keep this form updated. As Lynch notes: “One thing people should be doing is to revisit this nomination form, in the event of a marriage, or birth of a child.”
After all, whoever you wish to benefit from the payment when you’re 25 may not be the same person as when you’re 55.
If your employer only offers three-times death-in-service benefit, it may be possible to top this up via your scheme, so it’s something to consider asking about.
You have a personal pension
If you have a private pension on the other hand, such as a retirement annuity contract (RAC) or PRSA, your entire pension is usually paid as a lump sum to your estate.
With a PRSA, no income tax liability arises when it’s passed on, but inheritance tax rules will apply, so no tax between spouses or civil partners.
You’re approaching/have already retired
If you’re already in retirement, what happens to your pension will largely have already been determined but if you’re approaching retirement, it’s time to consider what the different options will mean for your family in the event of your death.
For example, if you have chosen to reinvest your pension fund in an approved retirement fund (ARF) rather than an annuity, it can pass after your death to your spouse or civil partner and become an ARF in their name. As a spouse or civil partner, they won’t pay any inheritance tax on the transfer, but will be liable to income tax on any money they withdraw from the fund.
Your ARF may also be passed on to your children. Children over the age of 21 will pay income tax but not capital acquisitions tax (CAT), and the inheritance of the ARF won’t affect their inheritance tax threshold (€310,000).
If you are a member of a DC scheme or have a personal pension plan you can re-invest these funds into an ARF.
An ARF, or AMRF for those with lower financial means, can be the best option if preserving the value of your capital is of utmost importance to you. However, if you live a long time in retirement the ARF may not last long enough, or it may lose some of its value due to market movements.
An annuity on the other hand provides certainty, as it converts your lump-sum into a guaranteed income until you die. However, the problem with this is that the annuity will also generally die with you. Where a surviving spouse may depend on this annuity income for their own retirement, it can be problematic, and while it is possible to buy a joint life annuity that will retain an income for your spouse, these are expensive and will reduce your own income in retirement.
“Most tend to buy one that dies with them,” says Gilhawley,
For example, with Irish Life, a fund of €350,000 will buy you an income of about €13,524 a year on one life. If you add a spouse, the income of the first person will drop to €12,425 a year, while in the event of their death, the surviving spouse will receive a reduced income of €6,212 a year.
Having all your pension fund wiped out on your death may also irk some people. After all, if you’ve contributed all your working life to this pension, and made the corresponding sacrifices to do so, is it fair that it should be wiped out like that?
In older defined benefit schemes (DB), employees had no option but to take an annuity. Last year however, members of DB schemes who had their funds transferred to a buy-out-bond were for the first time allowed to purchase ARFs, under new legislation.
Another issue is that while an annuity can be passed to a spouse – via the aforementioned joint life product – typically no-one else can benefit.
“In that regard, an annuity is quite restrictive,” says Lynch.
There are different types of annuity available – an enhanced annuity offers you a greater income if you have certain health issues, while you can also opt for a guaranteed annuity, which guarantees to pay out for a fixed period of time – up to 10 years say – after you die, but will be more expensive.
