If you worked in a job with a pension, this means you will receive ongoing benefits once you retire. A critical part of estate planning, then, will be figuring out what happens to that money when you die. The answer depends on the type of pension that you have. In some cases, you may be able to make joint or family elections when you enroll in your pension plan, which will make payments to surviving family members from your pension plan after you die. In other cases, your pension may have been structured as an account dedicated to you, rather than simply a promise of payments. And in that case, your surviving family members will also be entitled to this money. Here’s what you need to know.
A financial advisor can help you create an estate plan for you family’s needs and goals.
What Is a Pension?
A pension is known as a “defined benefits retirement plan.” The IRS defines a benefit plan as “a fixed, pre-established benefit for employees at retirement.” In other words, your employer guarantees how much money you will receive in retirement and on what schedule. The details of these plans can range widely. The most common pension plans promise you a fixed, monthly payment for the rest of your life once you retire, although you may occasionally find plans that promise a lump sum payment or annual amounts.
This is as opposed to what are known as “defined contribution retirement plans.” These are plans in which the employer provides a set plan for how much money it will contribute to your retirement during while you work there. These can also range widely. The most common defined benefit plans are 401(k)s in which your employer guarantees matching contributions based on your income. Although, as above, your employer may offer many other types of plans.
Relatively few employers still offer pension plans. Chiefly because, as the IRS notes in its definition, defined benefit pension plans are generally more expensive for the employer both in terms of payments and operating costs. Additionally, once an employer commits to a defined benefit pension plan it cannot retroactively decrease its benefits. Those costs become indefinitely fixed. An employer can cancel its pension program and stop adding benefits for new and current employees, but both past and present employees remain entitled to benefits they’ve already accrued.
What Happens to Pension Benefits When You Die?
Pension benefits exist in a legal in-between space. This is money that you earned during your working life. That’s why your employer cannot retroactively decrease or cancel benefits. They promised you this money as compensation for your work, making it yours.
But most employers also don’t promise a specific amount of money for your pension. Instead, a typical pension plan will promise conditional payments. For example, your pension may guarantee payments for the rest of your life, for a certain amount of time, until a fund runs out or based on some other condition. That means that your heirs don’t necessarily have a defined pot of money that they can claim in the same way that they can with a 401(k) remainder.
The result is that after you die your pension benefits are distributed based on the nature of your pension.
During estate planning you should review your pension to see what, if any, allowances it makes for surviving spouses and heirs. Some pensions end entirely with your death. Others allow for beneficiaries or may allow for continued payments to spouses and dependents.
Common Pension Distributions After Death
Some of the most common distributions for a pension after death include:
The Pension Ends With Your Death
This is very common. Many pensions are simply guarantees of payment through your retired life. In this case, the pension ends once you die. Your heirs receive nothing under these plans.
Many pensions, and particularly government pensions, are built with what are known as “survivor’s benefits.” These are benefits a surviving spouse or dependents receive after the retiree’s death.
Survivor’s benefits range widely depending on the nature of the plan. For example, the federal government offers options to make annuity payments for the rest of the surviving spouse’s life or to make a lump sum payment on the retiree’s death. This is a fairly common set of choices. Many, if not most, survivor’s benefits allow you to pass on a reduced version of the monthly payment that you received to your surviving spouse. Others, especially plans which your employer funds by purchasing an annuity in your name, can offer a lump-sum payout. The details vary widely from plan to plan.
Some pension plans allow for beneficiaries. In this case, during your working life you would name a beneficiary to your pension. After you die, your named beneficiary would receive the benefits under your pension. This can either come in the form of a lump sum payment or a series of monthly payments for a period of time.
Most of the time, when a pension offers you the option of naming a beneficiary it means that your employer has purchased a lifetime annuity in your name. They’re funding your pension by funding the lifetime annuity during your working life. As with all annuities this means that there’s a certain minimum amount of money to which you’re entitled, in this case based on the payments that your employer made. If you die before you collect that minimum amount, your beneficiary will receive it.
When a pension allows you to name a beneficiary, it’s common for the plan to have age minimums. For example, your beneficiary may receive a payment if you die before a certain age or if you die before entering retirement.
Pension plans are otherwise known as “defined benefit” retirement plans. When you die, your family members or heirs may have some rights to a payment from your pension plan. However this is very plan-specific, so it will depend entirely on the nature of your pension and the elections you made while working.
Tips Retirement Planning
- A financial advisor can help you pick retirement investments for your financial plan. Finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s free retirement calculator can help you figure out how much money you will need to pay for retirement.
Photo credit: ©iStock/jeffbergen, ©iStock/Charday Penn, ©iStock/whyframestudio