As part of a couple you may be used to arranging everyday finances jointly, but when it comes to long-term planning, do you know where you stand?
Pension planning tends to be something we do as individuals, but when one partner dies, it could have a big impact on the other’s finances. Cohabiting couples, in particular, can face a raw deal on private pension inheritance rights. Even if you’re married, or in a civil partnership, a partner may receive less than expected.
Inheriting the state pension
There are no longer rates specifically for married couples – the full state pension is £179.60 a week and the exact amount is based on your national insurance contribution record.
However, you may be entitled to extra payments if your spouse or civil partner dies. There were changes to the rules in April 2016 and the amount depends on whether you, and/or your partner, reached state pension age before or after that date.
Steve Webb, a former pensions minister and partner at the consultants LCP, says: “The most generous arrangements apply where the spouse who died came under the old system, as the new state pension has very limited scope for inheriting.”
If you reached state pension age before 6 April 2016 you fall under the old pension system. Its rules state that a surviving spouse can inherit at least 50% of your “additional” state pension, also known as state second pension. If your partner also retired under the old system, he or she can use your national insurance record to boost their basic state pension after your death.
If you’re under the new system, and getting more than the flat rate pension, then 50% of this extra money – the “protected payment” – can be inherited by a spouse or civil partner. If you’re cohabiting, you cannot claim any of a partner’s entitlement.
There’s a handy government tool that help you understand whether the state pension is inheritable. The Pension Service should be able to tell you how much, if any, of your partner’s state pension you would be entitled to.
Private and workplace pensions
Most workers pay into defined contribution pension schemes, whether through an employer or a personal pension, and receive payouts based on the investment performance.
If you’re married, any savings left in the pension when you die usually pass to your surviving spouse, unless you’ve stated otherwise on an expression of wish form. This allows you to nominate who you want to receive the money when you die. For a cohabiting partner to receive the fund, they need to be named on this form.
“Defined contribution administrators might ask for evidence that you’re living together but they don’t generally have hard rules,” says Helen Morrissey, the senior pensions and retirement analyst at Hargreaves Lansdown.
Final-salary schemes, based on earnings and how many years you’ve been working for an employer, may come with strict rules about who can receive your pension and how much. Some only pay out to cohabiting partners who have lived together for several years, Morrissey says.
Older sections of some big public sector final-salary schemes, such as the 1987 police pension scheme, refuse to pay anything to cohabiting partners.
The amount your partner receives depends on the type of scheme and your age when you die.
Generally, if it’s before you turn 75 beneficiaries can receive a cash lump sum, or keep it invested for their retirement, and will pay no tax. But if you are 75 or over, beneficiaries will need to pay tax on income taken out.
If you’re already receiving an income from an annuity, this typically cannot be passed on.
Anyone who has been divorced, then remarried, should check what both their former and existing partner will get, and take advice if this does not meet their requirements.
Keep your expression of wish or nominated beneficiary forms up to date, particularly if you cohabit or have been divorced.
“These forms are often neglected, but are very important in avoiding disputes over who should get what,” says Rebecca O’Connor, the head of pensions and savings at Interactive Investor. “Your will won’t necessarily cover your pension, as it doesn’t form part of your estate.”
If you have access to your pension account online, you can complete the form, and nominate anyone you want.
If you buy an annuity at retirement, think about what your partner will inherit. Lee Clark, a financial planner at the wealth manager Brewin Dolphin, says: “If one of you has more significant pension savings, you may choose to buy a joint annuity, providing an income for your partner.”
You can increase your state pension entitlement by filling in any gaps in your national insurance record with voluntary contributions, for example.
You can also save up to £2,880 in to a pension each tax year if you’re not working, and the government will boost this by £720 through tax relief. Your partner can pay into a pension on your behalf. Some employers will offer to match any extra contributions.
Your combined pensions will be included as part of the financial settlement if you divorce, and may be divided in one of three ways.
Offsetting: probably the most common way that pensions are divided on divorce, with the value of any retirement savings offset against other assets. For example, one partner might keep their full pension fund, while the other gets the family home. “This may keep things simple but the house won’t provide a retirement income unless it’s sold. A pension is a valuable asset that shouldn’t be overlooked,” O’Connor says. “So carefully consider your future needs, including retirement income, when deciding how to divide up assets as offsetting might not be the best option for you.”
Pension sharing: the partner with a smaller pension or without any at all has a share in their partner’s pot put in their name. In this scenario, Sarah Green, a family lawyer at Michelmores, recommends getting an actuary to do a pension sharing report. “The small financial outlay is worthwhile to ensure both parties are in an equal position on retirement.”
Earmarking: in this scenario, the partner without a pension may receive a lump sum on death before the ex-partner retires and/or income or lump sums at retirement. However, you must wait until your ex-partner retires to receive a share of the pension benefits, and income will be taxed at the pension scheme member’s rate. So if you are a basic-rate taxpayer, and your ex-partner is higher rate, this is a major disadvantage.
Suprised by state pension cut
When Sabine’s husband, Gregory, died last year she was surprised by the impact it had on her state pension. Her weekly payment, which was earned under the old system and set at £192.95, was cut, and from the date of his death she would get £174.39.
During years of working in corporate jobs, Sabine, 78, had built up entitlement to the full state pension which she thought was entirely separate to her husband’s. “I took steps to boost my pension right through my career and was able to retire with a good private pension as well as the state pension earned entirely from my contributions,” she says. “How can this possibly be fair?”
Sabine thought there must be a mistake and asked the Department for Work and Pensions to review her case, arguing she was being penalised because she was a widow.
But in September it told her that the decision was correct and the £18-a-week cut stood.
The maths behind the decision runs to five pages, but Sabine’s pension has been reduced because both she and her husband contracted out of the state earnings-related pension scheme when it existed.
This means the national insurance contributions that would have gone into it were directed into their private workplace schemes instead.
There is a limit on how much you are allowed to receive in retirement as a result of the opt-out, and because half of the pension Greg built up with his payments goes to Sabine, she has had her own state pension cut.
LCP’s Steve Webb says that if neither spouse had contracted out, Sabine would be due more, but effectively a deal had been done when Greg was still working. He paid a reduced level of NI and in return his scheme offered to make up what the state would have paid.
“For someone who has just been widowed it can come as a shock to find that their state pension could – in rare circumstances – actually fall,” Webb said. “In effect, the company pension is delivering part of the state pension on behalf of the government. The total income of the newly bereaved person should go up, even if one component – the state pension – has gone down.”
Webb says Sabine’s case is unusual because many women have lower national insurance contributions when they retire, so their state pension increases when they inherit some of their husband’s entitlement. However, she had already earned 100% in her own right.
Sabine gets £37.33 a week from Greg’s company pension for the bit linked to the contracting out, but it has been a shock to her to find that her state pension could be cut. “I know from everyone that I have spoken to that no reasonable person would regard this as a reasonable outcome,” she says.