What Happens to a Person’s Pension When They Die?

When an individual passes away, questions often arise regarding their pension benefits. A pension, a retirement plan where an employer provides income after an employee retires, can be a significant financial asset. The disposition of these benefits upon death depends on various factors, including the type of pension plan, beneficiary designations, and applicable federal and state laws. Understanding these elements helps beneficiaries navigate the process.

Pension Types and Death Benefits

Pension plans generally fall into two main categories: defined benefit (DB) plans and defined contribution (DC) plans. Each type handles death benefits differently, impacting how funds are distributed.

Defined benefit plans, often called traditional pensions, promise a specific monthly payment in retirement, based on an employee’s salary and years of service. Upon the death of a participant, death benefits often take the form of a survivor annuity, providing regular income to an eligible beneficiary. If there is no surviving spouse or other eligible designated beneficiary for a survivor annuity, some plans may offer a lump-sum payment to other named beneficiaries or the deceased’s estate. The specific payout structure and eligibility for non-spouse beneficiaries are determined by the individual plan’s rules.

Defined contribution plans, such as 401(k)s, 403(b)s, and Individual Retirement Accounts (IRAs), involve an account balance that grows over time through contributions and investment returns. Upon the death of the account holder, the remaining balance typically passes directly to the designated beneficiaries. Beneficiaries of defined contribution plans have several options for receiving the inherited funds. They can choose a lump-sum distribution, taking the entire amount at once. Another common option is to roll over the funds into an inherited IRA, which allows for continued tax-deferred growth.

Beneficiary Designations and Spousal Rights

Designating beneficiaries is a key step in ensuring pension benefits are distributed according to an individual’s wishes after their death. Naming both primary and contingent beneficiaries is important. A primary beneficiary is the first person or entity in line to receive the assets. A contingent beneficiary receives the assets only if the primary beneficiary is unable to do so, for instance, due to predeceasing the account holder. Regularly reviewing and updating these designations is important, especially after life events, as beneficiary designations generally supersede a will.

Federal law, specifically the Employee Retirement Income Security Act of 1974 (ERISA), provides protections for spouses regarding employer-sponsored qualified retirement plans. For these plans, a spouse has automatic rights to a survivor benefit or the account balance. This means that even if another individual is named as a beneficiary, the surviving spouse may still be entitled to a portion or all of the benefits unless they have formally waived their rights in writing, usually with notarized consent. This spousal consent protects a surviving spouse’s financial security.

If no beneficiary is named on a pension plan, or if the designation is invalid, the distribution of benefits can be complex. In such cases, the pension plan’s rules, and potentially state laws, dictate how the benefits are paid. Often, the benefits may be directed to the deceased’s estate, which can then subject the assets to the probate process. Probate is a legal procedure that can be time-consuming and may involve additional costs, potentially delaying the distribution of funds to heirs.

Process for Claiming Benefits

When a pension holder dies, beneficiaries must follow a defined process to claim the benefits. The initial step for any beneficiary is to contact the plan administrator or the deceased’s former employer. This contact provides beneficiaries with information specific to the deceased’s pension plan.

To process a claim, the plan administrator requires several documents. A certified copy of the death certificate is required to confirm the death of the pension participant. Beneficiaries also need to provide their own identification and any relevant pension plan documents the deceased may have kept. The plan administrator will then provide the necessary claim forms, which must be accurately completed. These forms ask for personal details of the beneficiary, their relationship to the deceased, and the preferred method of benefit distribution, if multiple options are available.

Once all required forms are completed and supporting documents are gathered, they must be submitted to the plan administrator. This submission can be done via mail, and some plans offer online portals. Keep copies of all submitted documents for personal records. Processing times for pension benefit claims can vary, from several weeks to a few months, depending on the complexity of the claim and the responsiveness of the beneficiary and the administrator. Beneficiaries should maintain communication with the plan administrator to follow up on the status of their claim.

Taxation of Inherited Pension Benefits

Inherited pension benefits are subject to income tax for the beneficiary. Distributions from pre-tax pension accounts, such as traditional IRAs, 401(k)s, and defined benefit plans, are taxed as ordinary income to the recipient. The benefits are added to the beneficiary’s other taxable income in the year they are received and are taxed at their individual income tax rate.

In contrast, qualified distributions from inherited Roth IRAs or Roth 401(k)s are tax-free. This tax-free treatment applies because contributions to Roth accounts are made with after-tax dollars, and the earnings grow tax-free if certain conditions are met. The tax advantage of Roth accounts extends to beneficiaries, allowing them to withdraw funds without federal income tax liability.

Required Minimum Distributions (RMDs) apply to most inherited pre-tax retirement accounts. For non-spouse beneficiaries of accounts where the original owner died after December 31, 2019, the SECURE Act mandates that the entire account balance be distributed within 10 years following the year of the original owner’s death. This 10-year rule applies regardless of whether the original owner had started taking RMDs. Exceptions to the 10-year rule exist for “eligible designated beneficiaries,” which include surviving spouses, minor children, disabled or chronically ill individuals, and individuals not more than 10 years younger than the deceased account owner. These eligible beneficiaries can stretch distributions over their own life expectancy, offering more flexibility in tax planning.

While inherited pension benefits are subject to income tax, the value of the pension may also be included in the deceased’s taxable estate for estate tax purposes. For many individuals, the federal estate tax exemption is substantial, meaning most estates do not owe federal estate tax. Estate tax is levied on the total value of the deceased’s estate before distribution, whereas income tax is levied on the distributions received by the beneficiary.