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Death Benefits - frequently asked questions
Important Information
In her Autumn 2024 Budget statement, Rachel Reeves announced the government’s intention to bring unused pension funds and death benefits within the value of an individual’s estate for inheritance tax purposes from 6 April 2027.
More detail can be found in our article Inheritance tax on pension death benefits from April 2027.
The following article is correct based on the current legislation and takes no account of the government’s proposed changes
Death benefits - general
Can pension death benefits be paid to a trust?
Yes. On death before age 75 benefits would pass to the trust without any tax deducted. On death after age 75, the provider will deduct a tax charge of 45% (known as a special lump sum death benefit charge). Beneficiaries can off-set the tax paid on the lump sum death benefit by the scheme administrator against the tax due on this trust payment. This may lead to a refund of tax.
Why is age 75 important for death benefits?
If an individual is under age 75 when they die, the fund will pass on completely free from income tax to any nominated beneficiary as a lump sum (subject to the lump sum and death benefit allowance), drawdown pension or annuity. For more information see our article on the Taxation of pension death benefits.
It’s worth remembering a dependant’s scheme pension is still liable for income tax, irrespective of the age at death. A scheme pension is not tested against the lump sum and death benefit allowance.
If an individual is over age 75 when they die, the tax charge on any income or lump sum payment is at the recipient’s marginal rate of income tax. There is no test against the lump sum and death benefit allowance on any taxable benefits.
HMRC Pensions Tax Manual PTM073100: Taxation of a defined benefits lump sum death benefit
HMRC Pensions Tax Manual PTM073200: Taxation of an uncrystallised funds lump sum death benefit
HMRC Pensions Tax Manual PTM073500: How a drawdown pension fund lump sum death benefit is taxed
HMRC Pensions Tax Manual PTM073600: Taxation of a flexi-access drawdown fund lump sum death benefit
HMRC Pensions Tax Manual PTM072110: Death benefits: types of pension: dependants' scheme pension: How a dependants’ scheme pension is taxed
What happens if benefits are not paid within 2 years?
Most payments, where the individual dies under age 75, must be made within two years of the scheme administrator being notified of the death of the individual (or the date the scheme administrator could first reasonably have been expected to know of the individual's death). Any payments to an individual made after the 2-year period is taxed at the recipient's marginal rate of tax, but there is no test against the lump sum and death benefit allowance on these payments.
The 2-year rule also applies to any beneficiary drawdown or beneficiary’s annuity.
HMRC Pensions Tax Manual PTM073100: Taxation of a defined benefits lump sum death benefit
HMRC Pensions Tax Manual PTM073200: Taxation of an uncrystallised funds lump sum death benefit
HMRC Pensions Tax Manual PTM073500: How a drawdown pension fund lump sum death benefit is taxed
HMRC Pensions Tax Manual PTM073600: Taxation of a flexi-access drawdown fund lump sum death benefit
PTM072430 – Death benefits: types of pension: beneficiary’s flexi-access drawdown from 6 April 2015: where a beneficiary had not designated funds in an arrangement into a drawdown pension fund before 6 April 2015
PTM072210 - Death benefits: types of pension: beneficiary's annuity: taxation of beneficiary’s annuities
Does the lump sum and death benefit allowance apply if benefits are not paid within 2 years?
No. If the 2-year rule doesn't apply, from 6 April 2024, tax-free lump sum death benefits are tested against the deceased’s lump sum and death benefit allowance, rather than the lifetime allowance.
Any lump sum death benefit paid from funds that crystallised prior to 6 April 2024 are not tested against the lump sum and death benefit allowance
Does an annuity have to be paid to a dependant?
No, joint-life annuities can be paid out to any beneficiary, if this is agreed when the annuity is bought. If an individual dies under the age of 75 with either uncrystallised rights or unused funds remaining in a drawdown pension, a beneficiary's annuity bought with the funds is paid tax-free.
However, the above does not currently 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.
HMRC Pensions Tax Manual PTM072200: Death benefits: types of pension: beneficiary's annuity
HMRC Pensions Tax Manual PTM072110: Death benefits: types of pension: dependants' scheme pension: conditions
Is there a maximum guaranteed period for an annuity?
No, annuity payments can be guaranteed for any period if this is agreed when the annuity is bought.
HMRC Pensions Tax Manual PTM62400: Guaranteeing a lifetime annuity contract
Who pays the income tax charge when an individual dies?
When an individual dies with uncrystallised benefits before age 75, these are tested against the lump sum and death benefit allowance if paid out as a lump sum.
Tax-free lump sum benefits in excess of the lump sum and death benefit allowance are taxed at the recipient’s marginal rate of income tax. It is the personal representatives responsibility for working out any chargeable amount over the remaining allowance of the deceased and reporting this to HMRC.
If the death benefits are paid out as income (drawdown or annuity) there will be no income tax charge.
If the individual dies aged 75 or over, any death benefits, whether paid out as a lump sum or taken as income, are subject to income tax at the recipient’s marginal rate of income tax.
On death before age 75 what tax is due if more than two years passes between the provider being aware of the death and the benefits being paid out?
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. Any lump sum payments made after the two-year period will be taxed at the recipient's marginal rate of income tax.
For a beneficiary’s annuity purchased from uncrystallised rights or from unused funds remaining in a drawdown pension, the beneficiary must be entitled to the annuity within two years of the scheme administrator being notified of the death of the individual, or they become taxable at the recipient's marginal rate of income tax.
On death after age 75 if there are uncrystallised benefits, what happens to the tax-free cash (pension commencement lump sum)?
On death after age 75, any death benefits are subject to income tax at the marginal rate of the beneficiary. The option to take tax-free cash dies with the individual.
If an individual directs who is to receive any benefits on their death rather than using discretion, are there any inheritance tax consequences of doing this?
As the individual will be taking the discretion away from the scheme administrator/trustee, any benefits paid will normally be included in the deceased individual’s estate and may be subject to inheritance tax. If the benefits are left to a spouse or civil partner these will usually be exempt from inheritance tax.
Death benefits - nominating beneficiaries
Death benefits - nominating beneficiaries
Here are some of the more frequently asked questions we've been asked about nominee flexi-access drawdown and successor flexi-access drawdown.
The individual wants the death benefits to be paid to their spouse (if the spouse is still alive) in the form of a nominee flexi-access drawdown. On the death of the spouse they want successor flexi- access drawdown to be paid to the children. Can the individual state in the nomination form that this is what they want to happen?
The individual can't dictate what form of death benefit the spouse can receive; nor can they influence what happens on the spouse's death.
All the individual can do is state who they'd like death benefits to be paid to on their death. If the scheme administrator is using their discretion, they use this information as a guide when deciding on the beneficiaries.
What format the death benefits take is down to the beneficiary who will choose from the options the scheme offers. If they choose flexi-access drawdown, they will be asked who they want any remaining funds to be paid to on their death.
If each succeeding beneficiary chooses nominee or successor flexi-access drawdown, it's possible for the death benefits to pass down the generations. However, as each generation can withdraw as much or as little as they like, the number of generations receiving benefits is likely to be limited.
Does the individual need to allocate a percentage to each nominee?
They do if they want the death benefits split in these proportions.
However, if they're nominating, say the children so that they can be offered the option of flexi-access drawdown, it would be less confusing to state the reason for nominating the children on an attached piece of paper.
The next question gives an example of when it might be useful to do this.
If the spouse has been nominated but says they would rather the death benefits were paid to the children, could the children have the option of flexi-access drawdown?
If they were dependent on the individual, they could. If they weren't dependent on them, this option would only be available if the individual had nominated them.
Non-dependent children who haven’t been nominated could only be paid a lump sum death benefit.
So, if an individual wants non-dependent children to have flexi-access drawdown as an option while a dependant is alive, they will need to be nominated.
If the individual does want non-dependent children to be given the option of flexi- access drawdown, how should the nomination form be completed?
The nomination form is being used for two purposes.
- One is to tell the scheme administrator how they want death benefits to be split on their death (if in fact that's what they want to happen).
- The other is to nominate a beneficiary so that they can receive nominee flexi-access drawdown if need be.
The individual can explain their wishes on a separate sheet of paper attached to the nomination form.
Why is it important for an individual to nominate a beneficiary for drawdown?
A dependant or named beneficiary can choose to take their benefits as a lump sum, an annuity or as nominee or successor flexi-access drawdown. The scheme administrator can only nominate a beneficiary to receive flexi-access drawdown where there is no surviving dependant or named beneficiary. If there is a surviving dependant or individual(s) nominated by the scheme member, the scheme administrator wouldn't be able to pay flexi-access drawdown to anyone else; only lump sums can be paid.
Apart from being good practice, it is imperative that an individual nominates and keeps their nominated beneficiaries up to date if they want them to have access to all death benefit options available under the scheme including flexi-access drawdown.
Disclaimer
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. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
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.