The importance of pension death benefits


Tracey Stewart

Tracey Stewart

Paraplanner


Since 6 April 2015, the rules governing pension death benefits have changed considerably, resulting in greater flexibility and tax efficiency depending on whether death occurs before or after age 75.

A further valuable feature of pension funds is that when calculating any potential Inheritance Tax (IHT) that may be due, death benefits from pension funds are not usually included in an individual’s estate.

The position and options for a pension fund following an individual’s death are summarised below.

Age at deathBenefits crystallised or notHow death benefits are to be paidWho Benefits can be paid toHow death benefits are taxed (assuming no Lifetime Allowance charges apply)
Under 75UncrystallisedLump SumDependent or nominated beneficiariesNo Tax Charge
 UncrystallisedPension IncomeDependent or nominated beneficiariesNo Tax Charge
 CrystallisedLump SumDependent or nominated beneficiaries No Tax Charge
 CrystallisedPension IncomeDependent or nominated beneficiaries No Tax Charge
75 and overAll BenefitsLump SumDependent or nominated beneficariesBeneficiary’s Marginal rate of tax
 All BenefitsPension IncomeDependent or nominated beneficariesBeneficiary’s Marginal rate of tax

Uncrystallised refers to a pension fund which is still in force and no lump sum or income has been taken.

Crystallised refers to a pension fund where the lump sum and or income has been taken either by an Annuity, Income Drawdown or Scheme Pension.

There are three separate categories of beneficiary, which are: dependent, nominee and successor. If a beneficiary does not fall into any of the three categories, they are unable to receive the death benefit as a pension.

  1. A dependent is a spouse, civil partner, child under 23, an older child who is dependent due to physical or mental impairment or someone who is financially dependent on the deceased. Also, someone in a financial relationship of mutual dependence with the deceased at the time of the time of their death.
  2. A nominee can be any person or charity nominated by the deceased or scheme administrator.
  3. A successor can be anyone nominated by the dependent, nominee, successor or scheme administrator to receive any remaining benefits on their death.

How can benefits be taken

Although an individual can nominate a beneficiary the scheme administrators can use their discretion and change the recipients if they feel it necessary.

If a beneficiary is found to be eligible to receive the death benefits, they can choose to take the fund as a lump sum or leave the money invested and draw a pension: for a nominee, Nominee’s Flexi Access Drawdown or for a successor, Successor’s Flexi Access Drawdown. This allows them to take an income or lump sum if and when required.

Dependents and nominees can take the death benefits as pension income. If the scheme administrators pay the benefits to an individual other than a surviving dependent or nominated beneficiary then the individual cannot take the benefits as pension income and it must instead be paid as a lump sum

It is possible for a nominated beneficiary to leave any remaining benefits which they have received to a successor on their subsequent death. The benefit would then be taxed at the successor’s marginal rate of tax.

E.g. John Smith dies at age 76 and he has nominated his wife, Karen, aged 70, to receive the benefit which is taxed at her marginal rate of tax

Karen then dies at age 74 and has nominated her daughter Lucy as her successor.

As Karen was aged below 74 when she died there is no tax to be paid. Therefore, Lucy will receive the benefit tax free.

Once the successor has received the benefit they can then, in turn, nominate a beneficiary to receive the pension fund on their death, thus allowing pension funds to pass down through successive generations.

This can be shown by continuing the above example:

Lucy received the pension fund when Karen died at age 74 and it was tax free.  Lucy then nominates her son Peter as her beneficiary and she subsequently dies at age 77. 

Peter is a higher rate tax payer and the when the fund is passed to him it is taxed at his marginal rate, (currently 40%), when he makes any withdrawals from the fund.

In turn Peter then nominates his grandchildren Hannah and David as his beneficiaries and he dies at age 78. Normally, his beneficiaries would be taxed at their marginal rate, however, as both Hannah and David are aged 11 and 13 and are non-tax payers, they can take income of £11,000* each year without paying any tax.

They can then stop taking any income should they wish and leave the fund in place until they retire.

 *Personal Allowance in tax year 2016/17 is £11,000

What should I do now?

It is essential that existing pension funds and expressions of wish covering the death benefits payable from them are reviewed. This will ensure that your wishes after your death are taken into consideration and the distribution of any remaining pension funds on your death can be made to your chosen beneficiaries.

Some older pension plans cannot accommodate the new rules around death benefits which may result in the only option available being the payment of a lump sum that would then be included in the recipient’s estate for IHT purposes.  Often the existing nominated beneficiary will be an individual’s spouse who is to receive 100% of the fund. However, it may be more beneficial to change and add named beneficiaries to ensure that everyone that you may wish to benefit from the fund can do so.

It is possible to change any existing nominated beneficiaries in order to take advantage of the new flexibility which pension freedoms provide, and the pension plan itself should also be reviewed to ensure it remains suitable for your requirements.

How to get in touch

If you would like to discuss anything contained in this blog, please contact a member of our Wealth Team by email on enquiries@jcwealth.co.uk or your usual local office financial planner. Find out more about our team by visiting our Wealth section here.

Nothing in this blog constitutes advice to undertake a transaction and professional advice. Taxation depends on individual circumstances as well as tax law and HMRC practice which can change.

Disclaimer: While all possible care is taken in the completion of this blog, no responsibility for loss occasioned by any person acting or refraining from action as a result of the information contained herein can be accepted by this firm.