Making a will is just the first step in sorting out your financial affairs for when you die – especially if you unspent money in a pension.
Most retirement savers do not realise that their pension savings are not covered by a will.
And like everything else someone owns, they cannot take the money with them when they die.
Checking out is one policy many retirement savers adopt, which means racing to spend everything before dying.
But the more aware realise that this is one way of quickly running out of cash.
Age makes a big tax difference
What happens to a pension and who pays tax on any unspent money depends on an arbitrary age limit of 75 years old.
Anyone who dies before they are 75 can nominate who inherits the money and they can take the cash as a lump-sum without paying any tax or leave the money in the fund and take the cash when they want.
That’s no inheritance tax for the estate and no income tax for whoever inherits.
The rules change when the retirement saver celebrates their 75th birthday.
After that date, the no inheritance rule stays in place but anyone inheriting pays income tax on their share at their marginal rate – which is the highest rate that they pay income tax.
QROPS and final salary pensions
The rules apply to defined contribution pensions, such as a SIPP or other personal pension and to expats with money in offshore QROPS.
If the retirement saver is over 75 years old and the person inheriting from a QROPS lives overseas, tax rules in the country where they live apply.
Some countries do not recognise a distribution from pensions in the same way as the UK, so it’s important to take professional legal advice in the place where you live if you are an expat.
The rules do not cover final salary or money purchase pensions that are ‘unfunded’. Their pay-outs are calculated under a different formula and there is no fund to inherit, although spouses may pick up a death benefit.