Using pension schemes to provide life cover

On death at any age, a pension scheme can pay out pension(s) to your dependants.

A dependant who is your spouse or civil partner, children under the age of 23 and anyone else who was fully or partly financially dependent on you (which could include, for example, an unmarried partner with whom you shared household expenses).

If you die before age 75 and without having started to draw any benefits, a scheme can pay out a tax-free lump sum to your heirs (who do not have to be dependants). The lump sum may be provided by life cover and/or through paying out any pension fund. 

If you die after turning 75 or having already started your pension or income withdrawal, a lump sum can still be passed to your heirs but only after deduction of income tax at 55 per cent. The lump sum may be provided by, say, an option available with an annuity or the remainder of your pension fund. Normally there will be no inheritance tax on this lump sum. The exception is where you had made choices to deliberately leave a bigger inheritance to heirs other than genuine dependants at a time when you knew yo did not have long to live.

It has long been possible to se pension contributions to buy life cover, which means that you get tax relief on the premiums you pay. The new April 2006 regime initially removed restrictions on the amount you could pay towards such cover. However, in a government U-turn, it is no longer possible to newly take out life cover through a person pension. Where you applied for your policy before 14 December 2006, the policy can carry on and you continue to get tax relief on the premiums. For policies taken out since, tax relief ceased from 6 April 2007 onwards. Employers can still provide life cover through occupational schemes.