FOOL'S EYE VIEW
What Happens To Your Pension If You Die Early?

By Jane Mack (TMFJane)
October 24, 2002

If you've been saving into a personal pension fund since you started you first job as a spotty-faced teenager, you're probably looking forward to a long and prosperous retirement. You might even have been sensible enough to have saved enough to retire at the earliest possible age which, depending on your pension scheme could be at the age of fifty.

Unfortunately, some of us get struck down by things like heart attacks, buses and lightning and we don't quite live long enough to get the full benefit of our pension or even to start claiming it. So what happens to your big fat pension fund in these circumstances?

If you've got a personal pension we all know that when you do start claiming from your pension fund that you have two basic options.

One is to use the money to buy yourself an annuity. You can choose to take up to 25% of the fund as a tax-free lump sum but the remainder has to be used to buy an annuity – an insurance-based product that provides you with an income for life. Once you've bought it, then you can say good-bye to your pension fund. After all, that's the deal – the insurance company gets your money and in exchange you get a guaranteed income until you die.

How much you'll get depends on whether you want a simple level income or one that rises in line with inflation and whether you want your spouse to get an income once you've gone. The more options you want the more it'll cost you.

The alternative option is to take income drawdown and it's only if you take this option that you can hang on to your pension fund and even pass it on to someone else if you die before converting it into an annuity.

Income withdrawal is an option which allows you to put off buying an annuity and live directly off the pension fund itself. Your fund remains invested under the scheme rules and you can simply draw on the profits and the actual capital although you do still have to buy an annuity eventually - by your 75th birthday at the latest.

If you choose this option, the amount you need to take out of your fund each year is based on the amount of the annuity you could have bought with your fund if you'd chosen to do so. You have to withdraw at least 35% each year and not more than 100% of the annual amount that an annuity would have given you. In other words, if an annuity would have given you an income of £10,000 a year, you have to drawdown at least £3,500 and not more than £10,000.

The plan with taking this option on retirement is that your pension fund remains comparatively intact. If you can invest it judiciously then the capital sum can provide you with an income and hopefully grow at the same time. It's not without risk of course. Should your pension fund perform poorly in this period you may well end up with a much smaller pension income when you do finally convert to an annuity.

If you pop your clogs during this time then your nominated beneficiary such as a spouse can either treat the whole fund as their own pension fund or they can take 65% of it as a tax-free lump sum if they wish. The reason it's 65% is because the Government taxes the whole of it at 35% - it's a way of them getting back the tax relief that you've been getting while making contributions.

If you die before you've even started claiming from your pension fund, then the whole of it can be transferred to your survivor as a tax-free lump sum. Yes, really. It's just about the only way you can free up the entire pension fund and get the money out of the system. Trouble is, you have to die before you start claiming – and, of course, it's not you who gets the benefits.

There are other options, of course, since you might want your pension fund to be used as an annuity for life for your survivor but the important thing is to check the terms of your pension even if you are a long way from retirement. If you die before you start claiming it, then you'll want it to go to a good home and in accordance with your wishes, won't you? It's your money, after all.

More: The Fool's Pension Centre | IR Personal Pension Guidance Notes (big, nasty 297 page pdf file!)