Beneficiary drawdown

How does beneficiary drawdown work?

When an individual dies, the scheme administrator or scheme trustees will normally decide who the beneficiaries will be. This will usually be at the scheme administrator/trustees’ discretion but could be at the individual’s direction. Our articles Death benefits – Discretion how to nominate a beneficiary and Death benefits – Direction explain the differences between the two options.

Once the beneficiaries have been identified, they’ll be asked which death benefit option they want to take. Assuming beneficiary drawdown is a feature of the plan and is chosen, they'll be asked who they want their beneficiaries to be on their death.

When someone in beneficiary drawdown plan dies, their beneficiaries can also be offered the option of taking the death benefit as a beneficiary drawdown. In this way, it’s possible for death benefits to be passed down the generations but of course normally the beneficiary will make withdrawals from the plan which will reduce the amount in the beneficiary drawdown plan. HMRC call the initial beneficiary drawdown plan a nominees’ beneficiary drawdown and later ones a successors’ beneficiary drawdown.

Like any drawdown plan, a beneficiary drawdown plan can be transferred to another provider. However, the beneficiary would have to be in beneficiary drawdown with the ceding scheme. If the individual’s scheme doesn’t offer beneficiary drawdown, it’s too late – the beneficiary can’t ‘transfer’ the death benefit to access beneficiary drawdown with another scheme.

Let’s look at an example of when a child is looking to claim a deceased parent’s pension.

Laura’s personal pension plan offers beneficiary drawdown. On her death at age 69, her only child Ian is asked if he wants the death benefits as a lump sum or as nominees’ beneficiary drawdown. He opts for drawdown and names his son Andrew and daughter Carol as beneficiaries with 50% allocation each. As Laura died before age 75, Ian won’t pay income tax on withdrawals from his nominees’ drawdown plan.

On Ian’s death at age 80, Andrew opts for a lump sum death benefit payment and Carol opts for a successors’ beneficiary drawdown, with her daughter Louise as beneficiary. As Ian died after age 75, Andrew will pay income tax on the lump sum and Carol will pay income tax on any withdrawals she makes.

The same choice will be given to Louise on Carol’s death (assuming there’s anything left of course!) and so it can go on.

How is beneficiary drawdown tested against the lump sum and death benefit allowance?

Although the lifetime allowance was abolished on 6 April 2024, the tax treatment of benefits pre and post age 75 remains unaltered. This means where an individual dies under the age of 75, the benefits are paid tax free.

Since 6 April 2024, it is only tax-free lump sum benefits that are tested against the lump sum allowance and lump sum death benefit allowance. Paying death benefit as beneficiary drawdown is not a lump sum benefit so it is not tested against either allowance.

This is a very important point, especially if the individual died before age 75 and has insufficient or no remaining lump sum death benefit allowance. If that is the case any lump sums would be partially or entirely liable to an income tax charge.  However, if the beneficiaries elected to take the benefits as beneficiary drawdown, they would not be tested against the lump sum and death benefit allowance, avoiding a tax charge. Once the benefits are in the drawdown plan, they can be paid tax free, even if the entire fund was paid out as one “income” payment.

For tax year 2023/24, if the death benefits were taken as beneficiary drawdown, beneficiary annuity or beneficiary scheme pension they were not subject to any income tax even if there was an excess over the lifetime allowance. Before the 2023/24 tax year, there would have been a lifetime allowance charge of 25% on any excess over the deceased’s lifetime allowance.

Pension schemes newsletter 149 — April 2023 

Can an individual transfer a beneficiary drawdown plan?

If the individual has a beneficiary drawdown plan it is possible to transfer that beneficiary drawdown plan to another provider. However, it must be a beneficiary drawdown to beneficiary drawdown transfer.

What can’t be done is for the beneficiary to ‘transfer’ the death benefit rights to another provider to get beneficiary drawdown where that’s not an option under the deceased individual’s scheme.

Can an overseas resident have beneficiary drawdown?

People resident outside of the UK can’t usually take out a new UK plan or change existing ones. A beneficiary who is resident overseas can’t choose to have benefits paid as beneficiary drawdown or survivor’s annuity.

Most providers (Royal London included) don’t allow beneficiaries resident in any overseas country to opt for beneficiary drawdown, as they do not have permission to market their products in the relevant country. It is essential to confirm the product providers permissions if your client is not UK resident.

At what age can an individual access beneficiary drawdown?

Beneficiary drawdown works in a similar way to flexi-access drawdown for an individual, but without the age restrictions in relation to access. This means the beneficiary does not have to wait until they’re age 55 before taking withdrawals from the beneficiary drawdown plan.

How is beneficiary drawdown taxed when it is inherited by subsequent beneficiaries?

The tax treatment of a beneficiary's drawdown payments starting on or after 6 April 2015 largely depends on the age of the deceased individual at death:

• Death before age 75 - the payments can normally be paid tax free.
• Death on or after age 75 - any drawdown payments are taxable at the recipient’s marginal rate of income tax. 

The taxation depends on the age at death of the last owner of the fund, so withdrawals from an inherited fund can be taxed differently as the plan passes to new beneficiaries on successive deaths.