Pension death benefits vary based on provisions in the retirement plan document—that's what determines the asset distribution options available to beneficiaries. Typically, pension plans allow for only the participant—or the participant and their surviving spouse—to receive benefit payments. In limited instances, some may allow for a non-spouse beneficiary, such as a child.
According to the Internal Revenue Service (IRS), the Employee Retirement Income Security Act (ERISA) "protects surviving spouses of deceased participants who had earned avestedpension benefit before their death. The nature of the protection depends on the type of plan and whether the participant dies before or after payment of the pension benefit is scheduled to begin, otherwise known as the annuity starting date."
If the plan participant is married with a joint-life payout option, the default beneficiary is the participant's spouse unless the spouse waives that option. The surviving spouse would need to contact the plan administrator to certify in writing that they are choosing to not receive survivor benefits, so that another beneficiary, such as a child, can. This statement must be notarized or witnessed by the plan administrator. If the plan participant is not married, they may designate another beneficiary.
After the death of the plan participant, the surviving family members should contact the plan administrator for information about whether the benefits will be distributed in a lump-sum payment or as an annuity. The plan administrator will also share details about rollover options.
Key Takeaways
- Pensions are retirement plans where the employer is responsible for making contributions. Sometimes employees contribute as well.
- Pension plans are expected to pay out a set amount of income to retirees, regardless of the performance of the investment portfolio.
- Typically, the spouse of the plan participant can receive the benefits upon the participant's death. Dependents may also be eligible.
What Is a Pension?
A pension is a type of retirement plan that requires an employer to make contributions to a pool of funds set aside for a worker's future benefit. The pool of funds is invested on the employee's behalf, and the earnings on the investments generateincome for the worker upon retirement. Pension plans typically offer a lump-sum distribution or payments in the form of an annuity.
Types of Pensions
There are two main types of pension plans: defined benefit and defined contribution. Each offer their own options for surviving family members who are designated as beneficiaries.
One option, for example, is a period certainannuity, which allows the participant to choose how long they will receive payments. This method allows beneficiaries to later receive the benefit if the period has not expired at the date of the plan participant's death. This is unlike the more conventional single-life annuity.
Defined Benefit
A defined benefit plan is what people normally think of as a pension. It is an employer-sponsored retirement planwhere employee benefits are computed using a formula that considers several factors, such as length of employment and salary history. It is called "defined benefit" becauseemployees and employers knowthe formula for calculating retirement benefits ahead of time, and they use it to set the benefit payout.The employer typically funds the plan by contributing a regular amount,usually a percentage of the employee's pay, into atax-deferredaccount. Depending on the plan, employees may also make contributions.
A defined benefit plan may pay out a lump sum to the designated beneficiary, or it may be distributed as an annuity. The pension payments may either end at the participant's death (referred to as a single-life pension) or they may continue to pay benefits to a beneficiary in a reduced amount (referred to as a joint-life or survivor pension).
If the participant selected a single-life pension, their monthly payments would be higher than if they selected a joint-life pension. Because the employer expects to have to pay benefits over a longer period of time, the joint-life option often comes with reduced payments to both the participant during their lifetime and the surviving beneficiary.
There may also be hybrid options that continue to pay the participant higher payments until their death (although not as high as the single-life option), with a reduced payment to the surviving beneficiary.
Over time, defined contribution plans became more popular than defined benefit plans, which were the traditional means of retirement planning.
Defined Contribution
A defined contribution plan is a retirement plan that's typicallytax-deferred. Employees contribute a percentage of their paychecks to an account that is intended to fund their retirements. The sponsor company will, at times, matcha portion of employee contributions as an added benefit.
With a defined contribution plan, such as a 401(k), the beneficiary can access the remaining funds in the retirement account via a gradual drawdown in installments, a lump-sum payment, or through the purchase of an annuity.
If a married plan participant wishes to designate a beneficiary other than the participant's spouse, the spouse must waive rights to the retirement benefits.
Generally, a pension refers to a defined benefit plan, not a defined contribution plan.
Advisor Insight
Gage DeYoung, CFP®
Prudent Wealthcare LLC, Colorado
Assuming your parent elected a period certain pension option for payment at retirement and named you as beneficiaries, you and your siblings would be entitled to the continuing payments until the period expires.
For example, if a parent elected a 20-year period certain pension option and passed away after 10 years from the date the pension started paying, their beneficiaries would be entitled to split the monthly payment for the next 10 years.
It will be important to find out what election was made by your parent prior to the payment start date. Many corporate pensions only offer single-life or joint-life payment options.
If that’s the case, the payments, unfortunately, stop at the passing of the original payee—or the passing of the original payee and their spouse, with a joint-life option.
How Do Inheritance Pensions Work With Taxes?
As long as there is a designated beneficiary, inherited pension benefits are most often not included in an estate and, therefore, are not eligible for inheritance tax when the value of your estate is determined.
How Is a Pension Paid Out After Death?
If you die before all of the assets in your pension have been paid out, then the remainder will be paid out to your beneficiaries. The payout can be either as a lump sum or as a fixed payment.
Who Receives a Deceased's Pension?
Who gets a deceased's pension is determined by the pension contract. Some pension contracts may stipulate that the pension ceases when the participant dies, while others may allow for the pension to be distributed to a surviving spouse or a dependent, such as a child.
The Bottom Line
Whether you can inherit pension benefits from a parent depends on the plan options that your parent selected. The tax treatments and methods available to you to access these funds vary based on those selections, as well.
To be sure of the options available to you, check with your parent's employer or the administrator of your parent’s plan. As always, speak to a tax professional to fully understand the tax consequences of any inherited pension benefits.
