Pension Provisions for Dependants

Depending on an individual’s job they may begin contributing to a pension fund early in their life. Indeed, many people begin contributing to occupational funds from the time that they start their first job, and at this point they are unlikely to have any financial dependants. As time passes, however, the chances of others depending on you financially increases, and it becomes important to know where your financial provisions stand with regard to them.

Death in Service

If you are contributing to a standard occupational fund – that is, an Approved Scheme (read our Understanding Tax Relief for more information) – it is highly likely that your plan will include provision for benefits in the case of what is known as ‘death in service’. This means that, if you were to die during the term of your pension plan, a dependant would be liable to receive a lump sum. If you are married or in a civil partnership, this individual will almost certainly be your spouse or civil partner, although the benefits also extend to other financial dependants in some cases.

The size of this lump sum will vary depending on the terms of your pension plan. However, for a standard final salary scheme it is likely to be four times your average annual salary. Furthermore, this sum is exempt from Income Tax, meaning that the beneficiary will receive the entire amount.

Personal Plans

If you contribute to a personal pension rather than an occupational plan, the benefits available to your dependants can vary wildly; it is very important to ensure that you choose a plan that would cater for your spouse or other beneficiaries’ needs adequately. In general terms, any benefits that your dependants receive will be drawn from the contributions made to the fund up to the point of death. This obviously means that those who have been contributing for longer, or who have made additional voluntary contributions, will leave their dependants in a better state financially.

Often the dependant is offered two options: they can either take the contributions that make up the existing fund as a pension income from the fund provider, or they can withdraw the fund as a cash lump sum. As with occupational schemes, this lump sum will be free of income tax.

Often, however, the most tax-efficient method of ensuring the largest income is to combine the two options outlined above. If the beneficiary withdraws the maximum lump sum, they will benefit from the tax-free status of the money. They can then use this cash to take on a purchase life annuity. This provides income through capital gains and interest, which is taxed at the savings rate of 20%. This is in contrast to 40% tax that would be suffered if the beneficiary was a higher-rate taxpayer, and took the fund as an income from the existing provider.

Clearly, the choice of provision for your dependants is a key decision that should be taken after some consideration. As with any other aspect of pension provision, it is highly recommended that you seek professional advice before making a decision.