In August we published an article explaining what happens if you die without leaving a valid will (click here to read it).  And whilst a will sets out how your estate should be shared out, any pension funds you have will not necessarily be treated in the same way.  Indeed, if you die before you retire, what happens to any funds you've accrued will depend on the type of scheme and its rules.

Here's our guide to death benefits for the main types of pension scheme:

Death benefits from stakeholder or personal pension schemes (including GPPs)

Death benefits under these schemes normally consist of a return of the accumulated fund, together with any life assurance benefits. The payment of these benefits is ‘discretionary’ which means the pension provider is free to decide who to pay the death benefit to. Often they will follow the deceased’s wishes, although they don’t have to. But because they hold that discretion, the benefits are not subject to IHT.

Note that, if the amount of the benefits (including those from any other pension schemes) exceeds the Lifetime Allowance (£1.8m in tax year 2011/12), the excess is taxed at 55% and the beneficiary has to pay it.

Death benefits from company (defined benefit) schemes

Most DB schemes provide for a ‘Death in Service’ benefit similar to a life assurance policy. This means that a lump sum is paid to a chosen beneficiary and this will likewise fall outside the estate for IHT purposes.

State Pensions and death benefits

The basic State Pension is paid only to you. It can’t normally be passed on to anyone else, although a surviving partner[1] may be entitled to some State Pension based on your NICs record but only if they haven’t already built up their own entitlement based on their own record.

However, if the deceased had built up an entitlement towards an additional State Pension[2] or State Second Pension then the surviving spouse or civil partner can get some of that pension.

In neither of these cases are lump sum benefits paid. Therefore any resulting pension payments will simply be subject to income tax in the hands of the recipient.

Protected Rights funds

Where an individual had contracted out of the additional State Pension arrangements they will have built up a Protected Rights fund from DWP rebates within their stakeholder or personal pension scheme. This fund is separate from the ordinary benefits and is normally used to secure an immediate pension for a surviving spouse or civil partner. However, if there is no such dependent, a lump sum can be paid to either any beneficiary nominated by the member, or, in the absence of a nomination, to the member's estate. It should be noted that any lump sum so paid cannot be classed as a discretionary payment and will form part of the member's estate and be subject to IHT.

From 6^th April 2012, the provisions governing protected rights funds change and they will then be treated as ordinary benefits. This means they will normally be paid as a lump sum on death.

And finally.....

Inheritance planning is an important element in preparing and updating your lifetime financial plans. With IHT kicking in on anything above £325,000 (a threshold which isn't going to rise for at least thee years), the tax bill can be very significant and can often be avoided or reduced with suitable planning. So speak to your Aspira adviser about IHT and lifetime financial plans. Call them on 080 048 0150.