Death benefits from April 2015

Major changes to the tax charges that apply to benefits paid on the death of a pension scheme member took effect from 6 April 2015.
Key facts

Major changes to the tax charges on death benefits paid from drawdown pensions and annuities took effect from 6 April 2015.

Drawdown pensions

  • On death before age 75 the benefits can be paid as a lump sum or as a drawdown pension to any beneficiary tax-free, irrespective of whether they derived from uncrystallised or crystallised monies.
  • On death after age 75 the benefits can be drawn down or paid as a lump sum taxed at the beneficiary’s marginal rate.
  • On death after age 75 the benefits can be paid as a lump sum to a trust with a 45% tax charge.

Lifetime annuities

  • On death before age 75 any beneficiary can receive the payments tax-free.
  • On death after age 75 any beneficiary can receive the payments taxed at their marginal rate.

The restriction that income can only be paid to a ‘dependant’ has been removed, which affects both drawdown pensions and annuities. This means that any beneficiary can be the recipient of pension death benefits from 6 April 2015.

These changes affect uncrystallised pensions, drawdown pensions and lifetime annuities.

 

Before 6 April 2015 what benefits could be paid depended on whether the funds were crystallised or not.  From 6 April 2015 it depends on the age of the current beneficiary of the pension benefit as at the date of death.  The tax treatment of the benefits is no different for crystallised and uncrystallised funds.  However, a lifetime allowance check still applies to uncrystallised benefits. 

 Death below age 75Death above age 75

Uncrystallised funds

The fund can be paid to any beneficiary completely tax-free as a lump sum, annuity or as a drawdown pension. 

The benefits will be tested against the lifetime allowance. 

 

The fund can be paid to any beneficiary, taxed at their marginal rate, as a lump sum, annuity or as a drawdown pension. 

The fund can be paid to a trust as a lump sum less a 45% tax charge.


Crystallised in drawdown

Can pass on completely tax-free to any beneficiary as a lump sum or as a drawdown pension. A drawdown fund can be used to buy an annuity at any time.

The fund can be paid to any beneficiary, taxed at their marginal rate, as a lump sum, annuity or as a drawdown pension. 

The fund can be paid to a trust as a lump sum less a 45% tax charge.


Joint-life annuity

Any beneficiary can receive payments tax-free.

Any beneficiary can receive payments taxed at their marginal rate.


Guaranteed-term annuity

Any beneficiary can receive payments tax-free.

Any beneficiary can receive payments taxed at their marginal rate.


Annuity-protection lump sum death benefit

Any beneficiary can receive the lump sum payment tax-free.

Any beneficiary can receive the lump sum payment taxed at their marginal rate.

The fund can be paid to a trust as a lump sum less a 45% tax charge.

Lifetime annuities

Annuities were brought into line with drawdown pensions from 6 April 2015; the restriction that income can only be paid to a ‘dependant’ has been removed. This means that joint-life annuities can be set up to be passed onto any nominated individual when they die. However, on death of the beneficiary the annuity will cease. This is unlike drawdown pensions where it is possible to continue passing on the fund until it eventually runs out.

The tax treatment of benefits has also been brought in to line, if death happened before age 75 the income is paid tax free.  For deaths age 75 and over the income is liable for tax at the recipient’s marginal rate of tax.

Since 6 April 2015:

  • joint-life annuities can be paid out to any beneficiary
  • guaranteed term annuities can be paid out to any beneficiary
  • where an individual dies under age 75 with a joint life or guaranteed term annuity, any payments to beneficiaries will be tax-free
  • if an individual dies under the age of 75 with either uncrystallised rights or unused funds remaining in a drawdown pension, any beneficiaries annuity purchased with the funds can be made tax-free
  • tax will continue at the dependant's marginal rate on annuities already in payment at 6 April 2015.

Scheme pensions

The above does not apply to scheme pensions. This means that the payment of a dependants’ pension paid from a defined benefit scheme will continue to be taxed at the dependant’s marginal rate, regardless of the age of the individual when they died.

Some other changes to annuity rules…

Annuities continue to be subject to the requirement to be paid at least annually and for the lifetime of the annuitant. However, the following has changed:

  • The 10 year cap on guaranteed periods has been removed. Annuity payments can be guaranteed for any period if this is agreed when the annuity is bought.
  • The annuity income can be varied, up and down, if it is agreed when the annuity is bought.

Dependants no more…

The restriction that income can only be paid to a ‘dependant’ no longer applies. Where someone has been nominated as beneficiary by the plan holder they can receive pension benefits.  This means that any named beneficiary can elect to take an income (including in the form of drawdown) as well as a lump sum. One advantage of a beneficiary taking drawdown is that on their death any remaining funds may be passed on to further nominated beneficiaries. This makes it possible to continue passing on the fund until it eventually runs out.

Lifetime allowance

The lifetime allowance still applies. If an individual’s pension has not already been tested against the lifetime allowance when that individual dies, it will be tested before being passed on. However, any pension funds that a person inherits will not count towards their own lifetime allowance.

There is a quirk regarding the lifetime allowance test on uncrystallised funds. If the member was aged under 75 when they died, and the uncrystallised funds lump sum death benefit is paid more than 2 years from the date the scheme administrator first knew of the member’s death (or if earlier, the date they could first reasonably have been expected to know of it), the uncrystallised funds lump sum death benefit is not tested against the lifetime allowance. 

PTM073200 - Death benefits: lump sums: uncrystallised funds lump sum death benefit

Two year rule

The rule that tax-free lump sum payments (where the individual dies under 75) must be made within two years of the scheme administrator being notified of the death of the individual remains. However, any lump sum payments made after the two year period will no longer be an unauthorised payment, i.e. chargeable at 55%. Instead, they will be taxed at the recipient's marginal rate.

Payments from a joint-life annuity, or an annuity purchased from uncrystallised rights or unused funds remaining in a drawdown pension, must be made within two years of the scheme administrator being notified of the death of the individual, or they become taxable at marginal rate.

A. Yes, as the individual died before age 75, the benefits can be paid to Joyce tax-free, irrespective of whether they derived from uncrystallised or crystallised monies.

A. The remaining funds would be passed on to any named beneficiary. If Joyce hadn’t nominated a beneficiary, it would be up to the scheme Trustees to use their discretion to decide who should receive the remaining funds as a lump sum.

As Joyce was over 75 when she died, any nominated beneficiary would receive the income payments or a lump sum after tax at their marginal rate.

A. If he died before age 75 the funds could be passed to his daughter tax-free as either a lump sum or as an income.  If he died after age 75 the lump sum or income would be taxed at the his daughters marginal rate of tax .

A. Where the individual can determine who will, rather than who may, receive lump sum death benefits, then those death benefits are subject to IHT in the individual’s estate.

Where the scheme administrator retains discretion over who will receive any lump sum death benefits, then those death benefits are not subject to IHT in the individual’s estate.

Death benefits discretion or direction

All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.
 
In addition, the information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice.

Last updated: 07 Aug 2017

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