Can You Inherit a Pension? How It Works and What to Do

Pensions are a key part of retirement planning. While their main purpose is to provide income in later years, many wonder if they can be inherited. The ability to pass on pension benefits to heirs is not guaranteed and depends on factors like the pension plan type and the original owner’s designations. Understanding these details is important for both pension holders and potential beneficiaries to ensure proper financial planning and asset distribution.

Understanding Inheritable Pension Benefits

The inheritability of pension benefits largely depends on the type of retirement plan involved. Pension plans generally fall into two main categories: defined benefit (DB) plans and defined contribution (DC) plans. Each type offers different provisions for beneficiaries upon the death of the plan participant.

Defined benefit plans are traditional pensions promising a specific monthly income stream in retirement, calculated based on factors like salary and years of service. Employers fund these plans and bear the investment risk. While providing guaranteed income for the retiree, their inheritability is limited to specific survivor annuity options, often for a surviving spouse. These plans commonly provide survivor benefits, usually as an annuity to a spouse, upon the worker’s death.

Defined contribution plans, such as 401(k)s, 403(b)s, and Individual Retirement Accounts (IRAs), operate differently. These plans involve contributions from the employee, employer, or both, into an individual account. The account balance fluctuates based on investment performance. Unlike defined benefit plans, defined contribution plans are generally fully inheritable, meaning the entire account balance can be passed on to designated beneficiaries.

Survivor benefits in defined benefit plans often require the surviving spouse to receive at least 50% of the retiree’s benefit. This annuity typically continues for the spouse’s lifetime. In contrast, defined contribution plans allow beneficiaries to inherit the accumulated funds, offering more flexibility in how and when money is received.

Designating and Identifying Beneficiaries

Designating beneficiaries for pension plans ensures benefits are distributed according to the plan participant’s wishes. A beneficiary designation specifies who receives benefits from a retirement account upon the account holder’s death. This designation bypasses the probate process, allowing for a more direct asset transfer.

Plan participants can name primary and contingent beneficiaries. The primary beneficiary is the first person or entity to receive benefits. A contingent beneficiary is a secondary recipient who receives benefits if the primary beneficiary predeceases the account holder or disclaims the inheritance. This layered approach helps prevent complications and ensures a successor is in place.

Keeping beneficiary designations current is important, especially after life events like marriage, divorce, or the death of a named beneficiary. Changes in family status do not automatically update existing beneficiary forms, potentially leading to unintended distributions. Some retirement plans may require spousal consent if a participant names someone other than their spouse as the primary beneficiary.

If no beneficiary is named, or if all named beneficiaries predecease the account holder, pension assets become part of the deceased’s estate. This can subject funds to the probate process, which is time-consuming and costly. In such cases, the plan’s default rules or state intestacy laws determine who receives the assets, which may not align with the deceased’s preferences.

Options for Receiving Inherited Pension Funds

Beneficiaries of inherited pension funds have various options for receiving the money, each with distinct tax implications. The choices available often depend on the type of pension and the beneficiary’s relationship to the deceased. Understanding these options helps manage the financial impact of the inheritance.

For defined benefit plans, a common option for a surviving spouse is a survivor annuity. This provides a continued income stream, often representing a percentage of the deceased participant’s benefit. The specific percentage depends on the plan’s provisions and the participant’s elections. If a joint and survivor annuity was chosen, the monthly payment to the retiree is reduced to account for the extended payout period over two lives.

For defined contribution plans, beneficiaries have more flexibility. One option is a lump-sum distribution, where the entire account balance is paid out at once. While this provides immediate access to funds, the distribution is taxable as ordinary income in the year received. A mandatory 20% federal income tax withholding applies to lump-sum distributions from employer plans.

Another option, particularly for spouses, is to roll over inherited funds into their own Individual Retirement Account (IRA) or treat the inherited IRA as their own. This allows funds to continue growing tax-deferred, and the spouse can name their own beneficiaries. Spouses can delay required minimum distributions (RMDs) until they reach their own RMD age.

Non-spousal beneficiaries face different rules, especially under the SECURE Act of 2019. For most non-spousal designated beneficiaries, the “10-year rule” applies. This rule requires the entire inherited account balance to be distributed by December 31 of the year containing the tenth anniversary of the account owner’s death. This can result in a larger tax burden over a shorter period.

Exceptions to the 10-year rule exist for certain “eligible designated beneficiaries” (EDBs). These include surviving spouses, minor children of the account owner (until they reach the age of majority), disabled individuals, chronically ill individuals, and individuals who are not more than 10 years younger than the deceased account owner. EDBs may still stretch distributions over their life expectancy, offering more favorable tax deferral.

The Process of Claiming Inherited Pension Benefits

Claiming inherited pension benefits involves a series of practical steps, beginning with identifying the appropriate contact. The first action is to contact the plan administrator or the deceased person’s former employer. These entities manage the pension plan and can provide specific instructions and required forms.

Beneficiaries will typically need to provide certain documentation to initiate the claim. A certified copy of the deceased’s death certificate is almost always required. The plan administrator may also request the beneficiary’s identification, such as a driver’s license or Social Security number, and information about the plan participant.

Once contact is made and initial documents are submitted, the plan administrator will guide the beneficiary through the formal claim process. This often involves completing specific forms provided by the plan. These forms confirm beneficiary status and allow the selection of a distribution option if multiple choices are available.

After submitting the completed forms and all necessary documentation, the claim enters a processing phase. The time frame for processing can vary, but plan administrators typically communicate what to expect regarding timelines. They will also provide further communication regarding the approval of the claim and the commencement of benefit payments or distributions.