Death benefit payments
On the death of a member of a registered pension scheme, their dependants may receive an increase in pension rights via the scheme pension, annuity, drawdown or the lump-sum death benefit.
For this purpose a dependant is defined as being the spouse or civil partner of the member at date of the member’s death; a child of the member under 23; or a child of the member over 23, but dependent on the member due to physical or mental impairment.
A person who was not married to/a civil partner of the member at date of the member’s death and is not a child of the member is also considered a dependant if the person was financially dependent on the member; the person’s relationship with the member was one of mutual dependence; or the person was dependent on the member due to physical or mental impairment.
Where there are no dependants, there is the option to pay a tax-free lump sum to a charity. The charity must have been nominated by the member. A tax-free charitable lump sum can also be paid alongside a taxable lump sum, for example, part can be paid to charity and part as a taxable lump sum to non-dependant relatives.
The tax position of death benefit payment options is outlined in Table 1, along with the impact of crystallisation and details of how tax treatment varies pre- and post-age 75.
Clearly the option of tax-free death benefits is preferable to a taxable income or taxed lump sum. Leaving a money purchase fund unvested provides the potential for a tax-free dependant’s inheritance up to age 75. This is also likely to be a better option for those in ill-health than an impaired life annuity unless income is a necessity. Of course vesting can be phased to leave some tax-free uncrystallised segments.
However, this strategy should be offset against the probability of survival to age 75, which is currently somewhere above 80 per cent.
Planners should consider the relative attraction of the immediacy of lump-sum death benefits taxed at either zero (unvested, pre-age 75 and lower than LTA) or 55 per cent (vested, post-age 75) compared to income, secured or otherwise, taxed at potentially significantly lower rates, even tax-free within the rising personal allowance. Additional income might also be gifted tax-free under the normal expenditure exemption.