What happens to your workplace pension on death?

A workplace pension is a type of pension set up by your employer to help you prepare for life after work. Some workplace pensions are called ‘occupational’, ‘works’, ‘company’ or ‘work-based’ pensions.

Under a workplace pension, a percentage of your pay is put into the pension scheme automatically every payday. In most cases, your employer also adds money into the pension scheme for you. You will also get tax relief from the government.

Some older-style or public sector pensions will be completely covered by your employer, without you having to pay in. This type of pension is not covered by this article.

Modern workplace pensions we use today began life after the 2008 Pensions Act.

In 2012, the government made it obligatory for companies of a certain size to offer a pension to their employees. It was then made mandatory for all companies in the UK to automatically enrol all eligible employees into a pension scheme in 2018.

You are an ‘eligible employee’ and will have been automatically enrolled in your employer’s workplace pension if you if all of the following apply to you and you’ve not opted out:

• you’re classed as a ‘worker’
• you’re aged between 22 and State Pension age
• you earn at least £10,000 per year
• you usually (‘ordinarily’) work in the UK

You can normally take money from your workplace pension when you reach 55 (57 from 2028) and most pension companies offer different ways you can do this.

Before you take money from your workplace pension, it’s important to take professional advice and consult an Independent Financial Advisor (IFA). This is because when and how you take your money can make a big difference to how much tax you might pay and how long your money will last.

If you die before retiring (by which we mean using your pension fund to purchase an annuity) the default position is that the value of the pension fund will be payable to your estate. However, this can be problematic if adding a relatively large pot of money to your estate causes inheritance tax (IHT) to be payable. As workplace pensions are relatively new, little consideration appears to have been given to this fact.

IHT is a tax that falls due on death or when gifts are made and is payable at a rate of 40% on the part of your estate that exceeds a certain threshold (currently £325,000) although this is subject to certain exemptions and reliefs.

The following example explains the potential IHT problem:-

John is in a long-term relationship with his partner Joanne. Neither of them have children. He is 50 and Joanne is 45. John owns the house that he and Joanne live in mortgage free. It is worth £300,000. He also has £10,000 in savings.

John has a workplace pension which has built up to £95,000. He has already made a Will and left his estate to Joanne. His funeral costs are £5,000.

In the event of John’s death, the £95,000 pension fund will be added to his £310,000 estate, making a combined gross estate of £405,000 and a net estate of £400,000 after deducting his funeral costs.

As the combined estate exceeds the £325,000 IHT threshold by £75,000, it will trigger an inheritance tax bill of £30,000; making a significant dent in the sum due to Joanne.

However, an inheritance tax problem such as this is easily avoided by taking simple steps as outlined in this article.

Most providers of workplace pensions permit the employee to name the potential beneficiary or beneficiaries of their workplace pension and this can be done in one of several ways.

So, in John’s example, the options are as follows:

1. John can do nothing, meaning that the pension fund will be payable to his estate and added to the value of it, as per our example. Before the pension fund can be released to Joanne, she would need to obtain a Grant of Probate for John’s Will in order to ratify it as his last Will and testament. Obtaining Probate can take several months, so as well as being disadvantageous from an inheritance tax perspective, this option would also delay the release of the pension fund to Joanne.

2. Alternatively, John can nominate Joanne as the beneficiary of his workplace pension with his pension provider. This requires John to complete an online or paper form to tell the pension provider that he wishes Joanne to inherit the pension fund in the event of his death. The benefit of doing this is that the money can be paid to Joanne without waiting for the Will to go to Probate. It is also binding on the pension provider. The disadvantage is that it will, normally, still be classed as part of his estate for inheritance tax purposes.*

3. A third option is for John to complete a ‘Letter of wishes’ with his pension provider, either in paper form or online, requesting the pension provider to pay the pension fund to Joanne on his death. This will mean that the pension provider will hold the pension fund under a discretionary trust for John and his eventual beneficiary or beneficiaries. The benefits of doing this are that the money can be paid to Joanne straightaway on John’s death without waiting for Probate and that the pension fund will not normally be added to the estate for inheritance tax purposes* saving, in our example, the £30,000 inheritance tax bill. The disadvantage is that the pension provider could, in theory, pay the pension fund to other beneficiaries who might make a claim on it. However, this is only likely to happen if there are other potential beneficiaries who were financially dependent on the person who has died immediately before his or her death or if they had married or entered into a civil partnership since completing the letter of wishes.

Steven Whiting, our Head of Private Client, said: “As the value of a people’s workplace pension funds increase in future years it will become increasingly important to think about what will happen to it on their death and to take steps to avoid any potential inheritance tax traps. Pensions are one of the important things that we consider when taking instructions for Wills or providing inheritance tax advice and this is one of the many reasons why it’s always best to use quality Solicitors like Graham & Rosen to do so”.

If you would like individual advice about what will happen to your workplace pension and other assets on your death, you should seek advice from a specialist Solicitor and make a Will. To make an appointment please contact our Wills & Probate department on 01482 323123 or email us at [email protected].

For financial advice, including on pensions, you should seek advice from an Independent Financial Advisor (IFA). Alternatively, you can get free advice from the Government backed pension advice service, Pension Wise https://www.moneyhelper.org.uk/en/pensions-and-retirement/pension-wise/pension-pot-options.

As a final note, please bear in mind that the options described in this article are specific to workplace pensions. Other types of pensions will operate under different rules.

* This article is based on information supplied by Nest Pensions which is one of the UK’s largest providers of workplace pensions with £31.5bn under management as of 23rd October 2023 (Please see: https://www.nestpensions.org.uk/schemeweb/nest/my-nest-pension/what-happens-to-my-pension-when-I-die.html).You should ask your own workplace pension provider which options they provide. The inheritance tax position was verified against HMRC’s Inheritance Tax Manual on the same date.