PensionsMar 23 2016

Treatment of beneficiaries

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
Treatment of beneficiaries

Almost a year on from the pension freedoms, the topic of death benefits is still causing a stir. The headline announcements – the abolished ‘death tax’ and drawdown for non-dependants – seemed reassuringly straightforward and were generally well received. And yet the devil crept so stealthily into the details that people are still getting to grips with some of the nuances.

At a glance

Since 6 April 2015, death benefits can be paid in different ways, as shown in Table 1.

Individual beneficiaries can now be classified in three ways, as seen in Table 2.

Nominees’ drawdown

The biggest cause for concern so far is the definition of a ‘nominee’. The legislation states that members or administrators can choose nominees. However, administrators cannot appoint a nominee if the member has a surviving dependant, or if the member had already nominated an individual or charity. A similar rule also exists for successors: however, as we are only a few months into the freedoms this has yet to cause many problems. At first glance, the rules appeared to supersede the administrator’s discretion to choose beneficiaries. This triggered concern that such death benefits may be subject to inheritance tax.

HMRC confirmed early on that this was not the case. The categories of ‘nominee’ and ‘successor’ are only relevant if the beneficiary receives death benefits in the form of a drawdown pension. The rules still allow administrators to choose beneficiaries as they wish; however, it does prevent them from offering beneficiaries drawdown in certain situations. So, while the initial fears around inheritance tax were unfounded, there is still an issue, which investors need to address if they want their beneficiaries to have the option of drawdown.

The following example shows the potential implications of the rules in practice.

Four investors, Mr A, Mr B, Mr C, and Mr D, all open new Sipps and plan to complete expressions of wishes. All four are married with grown up children in good health. Mr A decides to complete his expression of wishes at a later date and subsequently forgets. Mr B and Mr C both send letters to their pension administrators naming their wives as their beneficiaries. Mr D sends a letter nominating his wife, but also mentions that if the administrator does not pay benefits to her for some reason, he would like them to consider splitting the benefits equally between his two sons.

Mrs A notifies the scheme administrator of her husband’s death. As Mr A did not complete an expression of wishes, the administrator’s first choice is to pay benefits to his wife, as his only dependant. Mrs A informs the administrator that she has recently inherited a considerable amount of money from her late mother, and would prefer not to receive the benefits. She asks the administrator to consider paying the benefits to their son instead. The administrator investigates further and decides that Mr A’s son is the most appropriate beneficiary.

However, because there is a surviving dependant – despite the fact that she is independently wealthy – the administrator does not have the power to appoint nominees. Therefore they can only offer the son a lump sum.

When Mr B dies, his scheme administrator discovers that his wife also died shortly before him. As she was the only named beneficiary, the administrator investigates Mr B’s circumstances to decide who the beneficiaries should be. They discover that Mr B had no other dependants, and decide to pay the benefits to his three daughters. The administrator deems that, following Mrs B’s death, Mr B effectively had no nominated beneficiaries. As there are also no other dependants, the administrator decides that they are able to appoint nominees and can therefore offer drawdown to the daughters.

When Mr C dies, the scheme administrator contacts Mrs C to arrange the payment of the death benefits. She is surprised that she is named as the beneficiary – she tells the administrator that she and Mr C divorced several years beforehand. She thought Mr C had updated his expression of wishes to name their daughter instead. After their investigation the administrator does decide to offer the benefits to Mr C’s daughter. However, because they are bypassing Mr C’s expression of wishes, they cannot make her a nominee.

In the case of Mr D’s death, if the scheme administrator pays benefits to his sons, they will be able to offer them drawdown regardless of the circumstances. This is because the administrator does not need to be able to make the sons nominees: they can be classed as such because they were part of Mr D’s expression of wishes.

The ability for death benefits to remain in a pension for non-dependants is a valuable feature for many investors. As such, this quirk in the rules is an important consideration. In many situations, the simplest solution could be to provide the scheme administrator with a ‘secondary’ expression of wishes, like Mr D above. This lowers the risk of the administrator needing to appoint nominees themselves, by giving them a back-up plan in the event of unforeseeable circumstances. However, it should not be used as a substitute for regularly reviewing nominations.

Child dependants

The definition of ‘dependant’ is rather strict when it comes to children. A spouse or civil partner will continue to be a dependant indefinitely, as long as the marriage or partnership was in place when the member died.

However, a healthy child will only be a dependant until they reach their 23rd birthday. While this should not affect lump sum death benefits, it is problematic for dependants’ drawdown. Income paid after the child turns 23 would be an unauthorised payment, as the recipient is no longer a dependant. In practical terms, a dependant’s drawdown account for a child has an expiry date.

This is not a new issue, but discussions about it have reignited this year. There are probably two reasons for this.

Firstly, since the rules changed last year, death benefits have become a more prominent part of estate planning. Now that members can plan for any other individuals to receive death benefits as a flexible, ongoing income, this anomaly seems more of a stumbling block than it did before.

Secondly, a seemingly obvious solution appears to have been overlooked in last year’s changes When the legislation introduced the concept of nominees, many expected that a child reaching age 23 could then be classed as a nominee instead of a dependant, and continue to receive income. However, the legislation prevents this: it clearly states that a nominee’s drawdown account cannot be created from funds that have already been designated to a dependant’s drawdown account. It is also not possible to simply treat a child as a nominee from the beginning, as the definition of a nominee explicitly excludes dependants.

Many people believed that the original issue was an unintended consequence; a mistake. But then why was it not corrected with the introduction of nominees? Or has it simply been overlooked again?

It will be interesting to see if a small correction appears in a future finance bill.

Until such a time, we are left in a world where a member’s 22-year-old niece could take income for the rest of her life as a nominee, but a son of the same age, as a dependant, could only take income for a year.

Jessica List is assistant product manager at Suffolk Life