Understanding how death benefits work

  • Identify the ways in which pension benefits can be paid
  • Identify the different types of lump sum death benefits
  • Explain how death benefits are tested against the lifetime allowance
Understanding how death benefits work

With the exception of some contract based schemes, pension benefits do not generally fall within the member’s estate when they die – meaning they are free of inheritance tax. 

With trust based schemes, who the funds are paid to and how they are paid depends largely on the member’s wishes, and in certain circumstances, on the recipient’s requirements.

Only certain payments are authorised payments after the death of a member. 

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Legislation lists all of the authorised forms of pension and lump sum benefits that can be paid, along with the circumstances in which they can be paid, plus any conditions or restrictions that apply. 

In general, there are two types: pension benefits and lump sum benefits.

Pension benefits can be paid in the form of:

  • Flexi-access drawdown
  • Lifetime annuity 
  • Scheme pension. 

Where death benefits commenced on or before 5 April 2015 capped drawdown may also continue in payment to a dependant.

When flexi-access drawdown is paid to a beneficiary it is always kept in a separate arrangement to any pension funds they hold in their own right, and taking pension death benefits does not restrict the amount they can pay into their own pension fund, i.e. it does not trigger the money purchase annual allowance.

Types of lump sum death benefits

There are various authorised lump sum death benefits that can be paid from money purchase schemes.  

Each has a different set of conditions and characteristics, and the type of lump sum that can be paid varies depending on the type of scheme it is being paid from.  

  • Uncrystallised funds lump sum death benefit - where the deceased member had not taken benefits
  • Drawdown pension fund lump sum death benefit - where the deceased member or dependant was in capped drawdown
  • Flexi-access drawdown fund lump sum death benefit - where the deceased member, nominee or successor was in flexi-access drawdown
  • Charity lump sum death benefit - where a member has died with no dependants and had nominated a registered charity

Benefits do not have to all be taken in the same way. 

If the rules of a scheme allow, a single beneficiary could choose to take some of the fund as a lump sum, use some to purchase an annuity, and the rest to go into flexi-access drawdown. 

There is no limit on the number of beneficiaries, and different beneficiaries can take their benefits in different ways.

The beneficiary

The recipient of death benefits is called a beneficiary. 

There can be more than one beneficiary, and the way in which beneficiaries are determined depends on the rules of the scheme in question.  

In general, the scheme administrator will have full discretion over who receives benefits.  

The member is able to provide an expression of wish or a nomination stating whom they would like benefits to be paid to, but the scheme administrator is not bound to follow this wish.

There are no restrictions on beneficiaries. 

A beneficiary may well be a family member, but they could also be a friend or colleague.  

A member can also nominate another trust to receive the death benefits, such as a spousal bypass trust.

Three separate classes of beneficiary can receive pension income.

These are:

• Dependant

• Nominee

• Successor

These classes are not relevant to receipt of lump sum death benefits. 

If a beneficiary does not fall into one of these classes, they will not be able to receive death benefits as a pension but they will be able to receive the benefits as a lump sum.