Pensions and life insurance after death

This is an important area and the rules differ significantly between pensions and life insurance, so I will deal with each in turn.

Pensions on death:

The position depends on the type of pension and when death occurs.

Defined contribution pensions (including personal pensions, SIPPs, and most workplace pensions):

If the member dies before age 75, the pension fund can usually be paid out to beneficiaries completely free of income tax, provided it is designated or paid within two years of the scheme administrator becoming aware of the death. If the member dies aged 75 or over, beneficiaries can still inherit the fund but any withdrawals they take will be taxed as income at their marginal rate.

The fund can be paid as a lump sum or the beneficiary can draw it down over time, which gives flexibility.

Crucially, most defined contribution pensions are held in a discretionary trust. This means the pension fund does not form part of the deceased's estate for inheritance tax purposes. The member fills in an expression of wish form (sometimes called a nomination form) to say who they would like to receive the fund, but the scheme trustees have the final discretion. In practice, trustees usually follow the expression of wish unless there is a good reason not to.

Defined benefit pensions (final salary schemes):

These typically pay a spouse's or civil partner's pension, usually a percentage of the member's pension (commonly 50 per cent, though some schemes pay more). Some schemes also pay pensions to dependent children. There may be a lump sum death benefit as well, particularly if the member dies while still in service.

The rules vary between schemes, so the scheme booklet and rules need to be checked carefully. Cohabiting partners are not automatically covered, though some schemes have widened their rules.

State pension:

The state pension itself does not pass on death, but there are some limited rules allowing a surviving spouse or civil partner to inherit an uplift to their own state pension based on the deceased's national insurance record, depending on when both parties reached state pension age and the version of the state pension that applies. The rules changed significantly from 6 April 2016 when the new state pension was introduced.

Life insurance on death:

The key question is whether the life insurance policy was written in trust.

If written in trust, the proceeds are paid directly to the named beneficiaries and do not form part of the deceased's estate. This means the payout is not subject to inheritance tax and is not affected by probate. Payment is usually much quicker because there is no need to wait for a grant of probate or letters of administration.

If not written in trust, the proceeds form part of the deceased's estate. This means they may be subject to inheritance tax if the estate exceeds the nil rate band (currently 325,000 pounds, with the possibility of the residence nil rate band adding up to 175,000 pounds in qualifying cases). The personal representatives will need to obtain a grant of probate or letters of administration before the insurer will release the funds, which causes delay.

Some employer-provided death in service benefits (which are a form of group life insurance) are also held in trust by the employer or scheme trustees, and again the member can complete a nomination form to express their wishes.

Practical points:

1. Check whether an expression of wish or nomination form has been completed for each pension and update it if circumstances change, for example after a divorce, new relationship, or birth of a child.

2. Check whether any life insurance policies are written in trust. If they are not, consider whether it would be beneficial to place them in trust now, which is usually straightforward and costs nothing with most insurers.

3. If a pension scheme or insurer refuses to pay out, or pays the wrong person, there are complaints and dispute resolution procedures, and ultimately the Pensions Ombudsman can deal with pension disputes and the Financial Ombudsman Service can deal with insurance complaints.

4. On divorce, pension sharing orders or pension attachment orders can redirect pension benefits, but these require a court order. A divorce does not automatically change the position under the pension scheme or life insurance policy.

If you can tell me more about the specific situation, whether this relates to a death that has already occurred, planning ahead, a dispute about who should receive the funds, or something else, I can give more targeted guidance.