Listen to our latest podcast where Clare Moffat and Fiona Hanrahan from our Intermediary Development and Technical team delve into some vital areas of the tax treatment of pension death benefits.
In this podcast Clare and Fiona will look at key details from income tax charges on death benefits before and after the age of 75, the difference when death benefits go to a non-individual and lifetime allowance and when it is due on death benefits.
Q: Freedoms brought a win in terms of the taxation of death benefits didn’t they?
Yes and this is what makes passing on pension death benefits even more appealing than before. But remember this is only in relation to defined contribution schemes. The taxation of defined benefit schemes is still exactly the same and if someone dies under 75 in a DB scheme, income tax will be paid.
Q: So for defined contribution schemes – if someone dies under age 75 then it is income tax free?
So first of all let’s think about uncrystallised funds so this will only be relevant on first death. If the member dies before age 75 then it will be income tax free if it is paid within 2 years of the death or the scheme becoming aware of the death.
But as it is uncrystallised, LTA can still apply for those under 75 as there has been no BCE.
Death before 75 but paid after 2 years is taxed at marginal rate but LTA is not tested. The 45% special lump sum death benefit charge is a flat rate payable for non-individuals. Essentially if it doesn’t breathe – 45% applies. So that includes trusts, charities and companies.
Q: And what about from age 75 onwards?
Income tax will be charged at the recipient’s marginal rate of tax. So if a lump sum is taken then this could have major tax implications but remember income tax is only paid when drawdown funds are withdrawn so if the money isn’t touched – or kept within the personal allowance then there won’t be an income tax charge. Again, the SLSDB will apply if it is going to a non-individual. But there is no LTA test as the fund will have passed through a BCE at age 75.
Q: What about deaths in drawdown or beneficiaries’ drawdown?
For second and successive deaths or deaths in drawdown, the same income tax rules apply for pre and post 75. But there is no LTA test as there was either a BCE on the original member’s fund during their lifetime or on their death.
Q: So you mentioned that there is no LTA test if the member is under 75 but the fund is passed on after 2 years. If there is an LTA issue – is it a good idea to wait then?
It might seem like good planning to try to wait for the 2 years and pay marginal rate but no LTA excess charge. However, most schemes will not want to wait 2 years to pay out. Also if the beneficiary doesn’t make a choice or accept the benefit then there are not legally entitled to it. If they die, the SA will choose someone else the original member would have wanted. Plus – where is the money invested during this time? Has it been moved into cash? Do other beneficiaries want to take the money within the 2 years? So there’s a lot to consider.
Q: Is there anything else that advisers should be thinking about in relation to taxation of death benefits?
It is important to consider IHT but that will be on another podcast.
One other thing to mention is about the admin of LTA and death benefits on first death. We have found that many solicitors don’t understand LTA so it’s worth pointing out to our solicitor connections that they should get in touch with you as soon as they see a large fund. During life, at a BCE the scheme deducts any LTA excess charge but on death it is the responsibility of the personal reps (often solicitors) to pay this.
The scheme tells the PRs how much LTA has been used. The PRs have to notify HMRC and pay the bill issued. HMRC – issue the bill to the PRs. The beneficiaries will choose how they want to take any excess. If there are multiple beneficiaries then it is proportionate to the amount received and how it is taken – for example as lump sum or income.
Also, it the LTA at the point that the benefits are taken that is relevant not at the date of death. So it might be a good idea to wait a few months perhaps until the 6th April when the LTA will increase.