Benefits shake off their mortal coil

It was a shock to many, and when the full details came out confirming the headline it is safe to say many were surprised. The link between crystallised benefits and large death benefit tax charges was removed and only the age barrier of 75 remained. However, there can still be additional charges on uncrystallised funds if they take the members’ benefits over the lifetime allowance, and some new benefit crystallisation events have been brought in to deal with this.

Capped/flexi-access drawdown or uncrystallised funds

This is where the freedoms have had the most impact – the value of the pension fund at the date of death will be payable to the beneficiaries. There are no restrictions on the number of beneficiaries or who they can be.

So now it is possible to nominate any beneficiary and they will be a dependant, a nominee or a successor. A nominee is someone who is nominated but not actually dependent on the member and a successor is nominated by the beneficiary prior to her death. The beneficiary can choose how she wants to take the benefits, including:

• A lump sum payment from the scheme;

• Flexi-access drawdown;

• An annuity or

• A scheme pension.

The legislation on beneficiaries’ drawdown has been written in such a way that should a nomination not have been made, then the scheme administrator must pay any flexi-access drawdown to a dependant if there is one. This rule only applies to the beneficiary’s flexi-access and not lump-sum payments, so should the dependant not actually want or need the income or lump sum, it can be paid as a lump-sum death benefit to another person. This really shows the importance of nominations being kept up-to-date.

Money purchase scheme pension

Any benefit payable will depend upon the basis of the scheme pension and how long it has been in force. Any remaining funds can be used to provide benefits in just the same way as drawdown above.

Annuity (lifetime, fixed-term or investment-linked)

Whether there is any benefit entitlement will depend on the basis of how the annuity was set up, including how long the annuity was in force at the time of death. Annuities purchased after 5 April 2015 may be able to offer additional options when determining who the benefits can be paid to.

Taxation

The taxation of the beneficiary’s income or lump sum is determined by the age at date of death of the member, or if a second death, the beneficiary. This means that benefits can initially be taxed on first death and become tax-free on second or third death if the beneficiary should die before she reaches 75.

Beneficiaries’ flexi-access drawdown

Generally, if the member or beneficiary dies before the age of 75, the beneficiary’s flexi-access drawdown is paid tax-free. However, if the designation is made after two years and from uncrystallised funds, then any income paid will be subject to income tax at the beneficiary’s marginal rate

If the member or beneficiary died on or after the age of 75 the new beneficiary will pay income tax on her marginal rate on the payments she receives from the fund.

Beneficiaries’ annuities and guarantee payments

The rules on flexi-access drawdown payments also apply where the residual fund is used to purchase an annuity. In addition, if the annuitant dies before the age of, any guarantee payments will be tax-free. After age 75, tax will be applied at the beneficiary’s marginal rate.

Beneficiaries scheme pensions

Where the beneficiary uses any remaining funds to buy a scheme pension, payments received will be taxed at her marginal rate as income. This applies to both money purchase scheme pensions and to pensions paid from a defined benefit scheme under the scheme pension rules.

Lump sum payments

Lump sum payments paid in respect of a member or beneficiary who died before the age of 75 will be tax-free. Although again if the designation is made after two years then any payment will be subject to a tax charge, which is currently 45 per cent but proposed to move to marginal rate from the tax year 2016/17.

If the payment related to a member who died on or after age 75 then it is taxable and again this is currently 45 per cent with the proposal to move to marginal rate in 2016/17.

Lifetime allowance

There will be a lifetime allowance test at death on any uncrystallised funds, based on the member’s lifetime allowance, but the tax charge is payable by the beneficiary or her proportion of it should there be multiple beneficiaries.

There are generally three tests that could apply, but only if the designation occurs within two years of the member’s death:

• BCE 7 – a lump sum payment, chargeable at a 55 per cent flat rate on the excess over the lifetime allowance;

• BCE 5C – beneficiaries flexi-access drawdown, a flat rate of 25 per cent of the excess over the lifetime allowance;

• BCE 5D – annuity purchase with the residual fund, a flat rate of 25 per cent of the excess over the lifetime allowance.

Inheritance tax

Pension death benefits will not normally be subject to inheritance tax regardless of the age of the scheme member at death. However, if pension benefits have been paid from the scheme by way of a lump sum to the member’s beneficiaries those funds form part of the recipient’s estate for IHT purposes. If the beneficiary chooses to opt for flexi-access drawdown with the fund then the residual fund will remain part of the pension scheme and outside their estate on their death.

Revenue & Customs reserves the right to subject a pension fund to an IHT charge if it feels it has been used for tax avoidance purposes. From 6 April 2011, the failure of the member to exercise their right to draw benefits at his/her nominated retirement age will no longer result in an IHT charge, although a transfer within two years of death where the member was in Ill health could still cause the fund to fall within the estate on death.

Expressions of wishes

A scheme member’s request to pay benefits to named beneficiaries on his death is not legally binding on the scheme trustees – and there can be IHT implications where this is not the case. The member can submit an expression of wishes form to the trustees nominating the beneficiaries who he would like to receive any benefits available on his death.

With the changes to the death benefit options it is essential that expression of wish forms are reviewed frequently and new forms are completed on the death of a member, dependant, nominee or successor to ensure there is always a valid form on file. In the event of death occurring with no valid expression in place, scheme administrators will be required to look for any dependants, although it is still possible to pay a lump sum to anyone should the dependants not need or want the funds, just not a flexi-access drawdown.

Claire Trott is head of pensions technical of Ssas and Sipp provider Talbot and Muir

Key points

On 30 September 2014 the major overhaul of the death benefits for money purchase pensions was announced.

Capped/flexi-access drawdown or uncrystallised funds is where the freedoms have had the most impact.

Pension death benefits will not normally be subject to inheritance tax regardless of the age of the scheme member at death.

This article was amended on 29 June