Money Matters: What happens to your pensions and savings in the end?

Posted on Aug 3 2016 - 6:54pm by Samantha Clark
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Holly Mackay of Boring MoneyContinuing with our quest to understand pensions, investments and savings. We talk further with Holly from Boring Money about what happens to our investments when we die. It seems like the strangest thing to consider but to ensure we’re able to make the best decisions we need to be fully quipped with the knowledge!

What happens to a person’s savings and pension pots upon death and how they can secure their savings to ensure their families benefit from it?

As a first tip, for those retirees who wish to maximise the amount paid to their heirs, other savings and investments could be used up first because pensions are held outside of their estate.

When you finally hit retirement, you will increasingly need to decide how you’re going to use your pensions saving stash to create an income for your retired life – drawdown or annuity?  I think of drawdown like “twist” and annuities like “stick”.

A drawdown option keeps you invested, you have skin in the game still and your total sum can go up or down. This sum of money is typically invested in stuff which will create an income, usually through dividends from shares, or interest from bonds. At the moment an income of about 3% is a rough indicator of what a mixed portfolio might get you. So on a pension pot of £100,000 you might take £3,000 in income that year AND withdraw £4,000 of capital, ‘drawing it down’ to £96,000 (for example). And you keep the lump sum of £96,000 invested, ready for the next year. And that lump sum remains yours, and is inherited by your family if you die. The risk is that this fund could be depleted before your family get to inherit it.

The total amount your family will inherit will depend on how old you are when you die regardless of which pension options you choose. Put simply, if you’re under 75, the income or lump sum passes tax free, if you’re over 75, it’s basically taxed as income. But importantly, it’s out of the loop for inheritance tax (IHT).

With a conventional lifetime annuity– the “Stick” option -you swap your pot of pension money for a guaranteed income stream for life. Today you might expect to get about £5,000 a year (very rough estimate – depends on your age, health/lifestyle and the policy features you choose) from a £100,000 pension stash. That lump sum of £100,000 becomes the property of the annuity provider in return for paying your guaranteed income for life. However, you can include a 5 or 10 year guaranteed period with very little effect on the annuity rate which would still pay out your annual income for the remainder of the guarantee period and avoid your fund being wasted if you die prematurely.  A 50% spouse’s/dependent’s pension pays half the pension on death for the lifetime of the spouse if they survive you with only a modest reduction in the annuity rate given. It’s important to shop around on the open market for annuities (even if you have a GAR) to ensure you get the best deal.

As an aside, ISAs are treated slightly differently. The tax-free allowance you have amassed can now be passed on to spouses or civil partners and retain their tax-friendly status – if you pass them onto anyone else, including your children, they will become taxable. Also, ISAs form part of your estate, so will be subject to tax to the extent they exceed the inheritance tax allowance.

Finally, given pension funds are often the biggest assets people own, don’t forget to complete the death benefit nomination forms!

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