If you're fortunate enough to work for a company that offers you a pension plan, you can feel good knowing that come retirement, you'll have a steady income to draw from. But what happens to your pension if you die before you retire?
When you initially enroll in your employer's pension plan, you'll be asked to name a beneficiary. The beneficiary is the person who will receive your pension when you die. Much like naming a beneficiary on a life insurance policy, you can name one or more individuals to receive the benefits of your pension.
The importance of naming a beneficiary
If you don't designate a beneficiary or if the original beneficiary has since died and you failed to assign a replacement or don't have a contingent beneficiary, your pension will be distributed according to the rules specified in your pension plan and in some cases, your state of residence. In many cases, if a beneficiary is not specified, the proceeds will go into your estate and become subject to probate prior to distribution, a much longer, more complicated process than when you have specified an individual as beneficiary.
With some plans, that could mean having benefits distributed to a surviving spouse (if you have one), your children (if any), your parents (if still alive), or other next of kin. Therefore, if you want to have a say in who inherits your pension, assigning a beneficiary and regularly reviewing your beneficiary form is important.
It's important to assign primary as well as secondary beneficiaries in case something happens to your primary designation. It's important to review your beneficiaries regularly in case of life changes such as divorce, additional children, death of family members, etc.
The pension payout
How your beneficiary is paid depends on your plan. For example, some plans may pay out a single lump sum, while others will issue payments over a set period of time (such as five,10, or even 20 years), or an annuity with monthly lifetime payments.
If the pension owner dies after pension benefits have initiated, then the designated beneficiary will receive payout less the amount that has been distributed to the pension owner.
Claiming pension payouts as the beneficiary
If you were to die before you retire, your surviving spouse or other named beneficiary must contact your employer or the plan's administrator to make a claim on any available benefits. At that time, the plan administrator will generally request a copy of the death certificate. Depending on the type of plan, your surviving spouse or other named beneficiary will be notified as to:
- the amount and form of benefits (in other words, lump sum or installment payments under an annuity);
- whether death benefit payments from the plan may be rolled over into another retirement plan; and if a rollover is possible, the method and time period in which the rollover must be made.1
If you leave a job that offers a pension, it may be possible to take a lump sum payment at the time of your departure and roll over those funds into an IRA. This can help defer taxes due to the lump sum until you begin withdrawals during retirement. In addition, it may allow you to invest the money as you wish.
Understanding taxes on pension payouts
Regardless of how it’s distributed, your beneficiary will be required to report the proceeds from your pension as income on his/her taxes. However, as mentioned above, there may be ways to shelter pension money from taxes by rolling funds into an IRA. Check with your financial professional, as state laws vary and tax issues also depend on the pension contract.
What happens to my pension if I die after retirement?
If you die after you have already started drawing your pension, the amount your beneficiaries receive will be based on how much you have drawn from pension and/or the payout option chosen. If there is cash remaining, your beneficiaries may be able to withdraw a lump sum or access regular payments, depending on specifics on your pension contract.
As a part of your retirement planning, don't forget to make sure you have named a beneficiary to your pension plan. To learn more about pensions and defined benefit plans, visit the Protective Learning Center.
Sources:
1. General Rule for Pensions and Annuities, IRS, December 2022
WEB.1950.03.16
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