Will Your Spouse and Children Receive Pension Death Benefits?
- Surviving spouses and dependent children may be eligible to receive pension death benefits. Learn what tax consequences these payouts have for beneficiaries.
Surviving spouses and dependent children may be eligible to receive death benefits from the pension of a loved one, but many beneficiaries wonder about the tax consequences of these payouts. In this article, you’ll learn what a death benefit is and whether beneficiaries must pay taxes on the payments they receive.
Have Medicare questions?
Talk to a licensed agent today to find a plan that fits your needs.
What Is a Pension Death Benefit?
A pension from a union, private company or government agency may provide monetary benefits to surviving spouses or dependent children upon the death of the plan participant. Known as pension death benefits or inherited pension benefits, these payouts typically take the form of ongoing payments representing a percentage of the amount the original owner received during retirement. That percentage may vary depending on the plan’s terms and options chosen by the original owner.
If a pension plan owner dies prior to retirement, designated beneficiaries may receive a lump sum payment. The amount typically reflects a multiple of the deceased’s yearly salary.
How Can You Determine if You Qualify for Death Benefits?
Not all pensions provide death benefits, and those that do typically limit beneficiaries to spouses and dependent children. If you are the spouse or dependent child of somebody who's passed away, your loved one’s employer or the plan administrator can explain the terms of the pension and help you determine if you qualify for death benefits.
The plan administrator can also help you navigate the process of filing a claim, including executing a rollover if that option is available. You should be prepared to furnish a copy of the death certificate during the claims process.
If your claim is approved, a representative from the plan should notify you with details about how much you'll receive and whether it will take the form of regular payments or a lump sum distribution. You should also be notified about whether the payout can be rolled over into another retirement plan.
Are Pension Death Benefits Taxable?
Although the taxability of pension benefits depends largely on the specifics of the plan and the payment structure, most beneficiaries must pay taxes on money received. Recipients should typically report this inherited pension income the same way the plan participant did. However, if a disbursement was previously subject to an estate tax, you may be entitled to a yearly deduction and should consult a qualified tax professional to find out the best way to proceed.
Other unique tax situations include:
Purchased Pension Death Benefits
Some death benefits purchased through a pension plan function similarly to life insurance, which means they’re only taxable if the payout amount exceeds the purchase price. If the payout does exceed the original purchase price, only the amount over what was paid is taxable.
Rollovers
If pension death benefits involve a defined-contribution plan such as a 401(k) or are paid as a lump sum distribution, there may be an option to roll them over into a new retirement plan. Rollovers may allow beneficiaries the option to continue growing their income in a tax-deferred environment until they’re ready to begin receiving payments.
Death Benefit Only Plans
In addition to inherited pensions, some companies may offer death benefit only plans (DBOs), that pay out to an employee’s surviving spouse and/or dependent children upon the death of the participant. Because DBOs are typically tax-deferred so the employee doesn’t generate taxable income, they are taxable to the beneficiaries.
DBOs may be set up to avoid estate taxes by specifying beneficiaries by type rather than by given name and by limiting the employee’s rights and control over the plan. Payments are still taxed as ordinary income.
Have Medicare questions?
Talk to a licensed agent today to find a plan that fits your needs.
When Should You Consult a Professional?
Because tax implications vary widely between plans and IRS rules may be complicated, recipients of pension death benefits may find it helpful to consult a tax professional. An experienced estate lawyer may also be able to help beneficiaries determine what tax consequences accompany their benefits. Older Americans looking to gain an understanding of pension death benefits and tax consequences for estate planning purposes should consult an estate planning attorney, who can provide advice and guidance going forward.
