What happens to a final salary pension on death?
Final Salary Pension (Defined Benefit) schemes usually provide entitlement to a spouse’s, civil partner’s, or dependant’s survivor’s pension in the event of the member’s death pre-retirement or post-retirement.
However, if the member is a deferred member of a deferred benefit scheme (e.g., Final Salary Scheme), there is unlikely to be any lump sum death benefit paid out. As most schemes are now closed and many employees have moved onto new arrangements, this is the most common situation we see.
The scheme may allow a refund of contributions, but it might be a more attractive solution to transfer benefits to a money purchase arrangement (defined contribution – pension pot) that will allow the whole fund value (via a Cash Equivalent Transfer Value) to be paid out in the event of death.
Analysing death benefits for different types of pensions is essential when considering passing wealth down through the generations. This is where defined contribution pensions are vastly superior as they can be inherited either as a cash lump-sum or as a pension and, any beneficiary can be nominated, not just family members.
A Final Salary Pension cannot be passed down the generations as it was never designed to do this. The original design was based on a job-for-life (i.e., one employer for life) followed by a pension until death for the member and their spouse only.
However, the terms of your scheme will make provision for your spouse and any other financial dependents in the form of a reduced survivor’s pension. The scheme rules will dictate exactly what will happen in the event of your death.
Alternatively, Final Salary Schemes should give you the option of transferring out into a defined contribution pension (pension pot), which you can pass on to your family. However, a transfer may not be the best option for you, so it is best to ask a suitably qualified and regulated financial adviser to review your full circumstances.
In the event of death in service, a defined benefits lump sum death benefit is paid to the members’ beneficiaries. The lump-sum would be free from tax for members who were under the age of 75 at the date of death and the benefits are paid out within two years.
In addition to any lump sum paid to those who die in service, there is often a spouse’s, civil partner’s or dependant’s pension paid too. The scheme rules will state how these benefits are also calculated, usually as a proportion of the member's benefit and it is common that 50% of the member's pension would be payable.
If the lump sum was in excess of the Lifetime Allowance (LTA) a tax charge of 55% is levied on the lump sum excess paid over the LTA limit which currently stands at £1,073,100 for the 2021/22 tax year.
If a member died in retirement, then their pension would usually be payable for the remainder of any guaranteed period (often 5 years starting from the commencement of retirement) and a spouse’s, civil partner’s or dependant’s pension paid as a fixed percentage of the member’s pension at the date of death (usually 50% of the pension before the member’s death).
This article looked at an introduction to what happens to Final Salary Pensions on death but there is a great deal more to consider than is covered here. The advice can only be given to an individual after a thorough assessment of all personal (and their partner’s) financial circumstances.
Would you like to get some professional advice to gain increased financial peace of mind and family security? If the answer is yes, the next step is to have an informal exploratory chat with a qualified adviser to see if it is worthwhile proceeding to the formal process known as regulated financial advice.