Join our community of smart investors

Which pension looks after your family best?

Sitting your kids down to tell them what kind of pension you’ve got will probably just make them yawn a lot. But later on, they might wish they’d paid more attention because the pension you have makes a big difference to the benefits they’re entitled to and how long it takes to receive them.

The type and number of pension pots we end up with is usually dictated by how and where we work. They can range from defined contribution (DC) and defined benefit (DB) workplace plans, to self invested personal pensions (Sipps) and small self administered schemes (SSASs), which are similar to Sipps and a favourite with small family-run businesses

In many ways, DB scheme members are the spoilt brats of pension savers as their employers shoulder all the investment risks and decisions. And pensions Lifetime Allowance rules are kinder to them.

DC and Sipp pension savers, on the other hand, are on their own as their pot comes with no guarantees. If the pension does well, its value could breach the Lifetime Allowance limit and some of the pot could be swiped by the taxman.

Pensions are for the living first and foremost. But which pension is better for your family when you die? DB schemes tend to be less generous, offering a reduced pension to a spouse or civil partner, with a lump sum based on, say, two to four times your salary if you die before you retire. Cohabiting partners and older children typically get nothing although trustees can bend the rules on occasion.

“The rules of these schemes shape the death benefits far more prescriptively than other schemes,” says James Jones-Tinsley, self invested pensions technical specialist at Barnett Waddingham.

Compare that to DC schemes and Sipps where any named beneficiary can inherit the whole of your remaining pot as a lump sum or draw it down as income, usually entirely free of inheritance tax (IHT), and if you die before the age of 75 free of income tax too. If you die at or over the age of 75, your beneficiaries will pay income tax on the money whichever way it is withdrawn. Note that a pension transfer from a DB scheme into a Sipp within the two years preceding death will almost certainly lead to a challenge from HMRC that the pot is liable for IHT.

SSASs broadly follow the same rules as Sipps but these schemes have other members who are usually also the trustees. The trustees will consider the wishes of the deceased member, and talk to the executors and family members. How quickly a member’s assets are distributed depends on the composition of the portfolio.

“SSASs have the ability to shift assets around so that more liquid ones are in the names of older members and less liquid ones are in the names of younger members,” explains Jones-Tinsley.

But because SSASs are likely to hold commercial property with each member owning a share, it can take longer to get to the point where the distribution can be made. And depending on the liquidity of the assets, SSAS trustees can pay benefits as an ongoing pension rather than a lump sum.

Sipps and SSASs can continue paying benefits to multiple generations. The only limit is how long the funds last.

Whatever the differences, it’s important for pension savers to complete a nomination or expression of wishes form to guide trustees. If, for example, your adult children are not named on that they may not receive anything.

“Trustees are not bound by what you say but they try to follow those wishes closely,” says Jones-Tinsley.

And whatever you do, don’t mention your pension in your will. Otherwise it could be treated as part of your estate - which you don’t want.