Where benefits could be taken in the form of a tax-free lump sum it would seem an obvious choice, although one advantage of taking a more gradual drawdown pension instead is that anything not taken out of the pension wrapper would have been free from Inheritance Tax on the beneficiary’s death. This consideration remains a factor today, and will be discussed later on.
Anything left on the dependant’s death that had not been taken out of the pension could be used to provide a drawdown pension or annuity to another dependant (if any) of the original member, or otherwise paid as a lump sum to another beneficiary.
Post-reform position
Since April 2015 it is broadly correct to say that the key factor in determining the tax treatment applicable to death benefit payments is whether the member has reached the age of 75 at the time of their death.
Any lump sum or drawdown pension paid to a dependant or another beneficiary – provided in the case of a drawdown pension that no payments had been made to the beneficiary before 6th April 2015 – out of a pension fund in respect of a member who dies before reaching the age of 75 is tax-free.
It does not matter whether the member had crystallised all or part of their pension savings or not. The same goes for beneficiary’s annuities that were not in payment before 6 April 2015, as long as the member died on or after 3 December 2014.
There are a couple of noteworthy exceptions. The first is that if a lump sum is not paid within two years of the death of the scheme member then it will be subject to tax. The same applies to a drawdown pension that is not designated for payment to the beneficiary in question within two years of the member’s death, although drawdown pension payments made after that date will not be subject to tax provided designation occurs within the two-year time limit.
The second exception is that if the death benefits are being paid from funds that were uncrystallised at the time of the member’s death they will be subject to a test against the member’s (not the beneficiary’s) remaining Lifetime Allowance.
