Death benefits: Discretion and how to nominate a beneficiary
This article describes what how discretion works and how a nomination form (expression of wish) can be used to let the scheme administrators/trustees know the individual’s wishes as to whom death benefits should be paid to.
Our article on Direction describes what direction is and when it may be used.
- Generally, paying death benefits out at the discretion of the scheme administrator/trustees will mean benefits are paid outside the estate and therefore IHT free
- An individual can provide a nomination/ expression of wishes to the scheme administrator/trustees to let them know who they want their benefits paid to, but this is not binding on the scheme administrator/ trustee
- Once a plan is set up under discretion, the individual can’t subsequently choose direction under that scheme
- Beneficiary drawdown, if available under a plan, can only be offered to a dependant or a nominee of the deceased
What is discretion?
When a member of a pension scheme dies, the scheme administrator/trustees must pay the death benefits to someone. The process of choosing the beneficiary(ies) can either involve the scheme administrator/ trustees using their discretion, or the individual directing the choice (known as direction), before their death, when the plan is first taken out. The way the choice is made can affect the inheritance tax payable on the benefits.
Discretion is the default position with most pensions where the scheme administrator/trustees uses their discretion when deciding who should receive the death benefits from their pension arrangement. The individual can tell the scheme administrator/trustees who they would like them to pay death benefits to (sometimes referred to as an expression of wishes), but the scheme administrator/trustees doesn’t have to follow their wishes. This usually means the value of the pension savings won't be counted as part of the individual’s estate therefore it won't be subject to inheritance tax.
Opting for discretion is a one-off decision and if the scheme administrator/trustees are asked to use discretion, the individual can’t change their mind and opt for direction later. This means direction can only be selected at outset of a new plan.
The rest of this article discusses discretion and how to nominate beneficiaries. See our article on Direction to see the limited circumstances where it would make sense to use direction.
How does the scheme administrator/trustee use their discretion?
If the scheme administrator/trustees are asked to use their discretion when paying a death benefit, they will consider the individual's wishes, but they aren't bound by their request.
Discretion does mean a certain loss of control by the individual. Although the scheme administrator/trustees will usually follow the individual’s wishes, they don’t have to. The scheme administrator/trustees must investigate the individual’s personal/family circumstances at the time of death and may end up distributing the death benefits differently to the individual’s wishes. The scheme administrator/trustees won’t go against the individual’s wishes lightly and the reason for the decision has to be justifiable in a court of law if need be.
Discretion can be particularly useful if the individual hasn’t kept the expression of wish form up to date and original beneficiaries have died and/or potential new ones have been born or acquired.
Will inheritance tax be due if benefits are paid by discretion?
If the scheme administrator/trustees of the pension scheme have discretion over who to pay death benefits to, the benefits are normally free from inheritance tax.
There are limited circumstances that IHT may be payable under a pension, where death benefits are paid out at the discretion of the scheme administrator. These are:
- there is a transfer of pension savings when the individual is knowingly in ill health and does not live for two years following the transfer. The same applies where a trust is set up to receive the death benefits from a pension plan that is not held under trust, for example a retirement annuity contract/s226.
- where contributions outside their normal pattern of contributions have been made within two years of death and the individual was in ill health when these were made. See more here (link opens in a new window).
- the deceased has made contributions to a pension scheme for someone else who is not their spouse or civil partner and not as an employer and the transfer doesn’t fall within the normal expenditure out of income exemption (link opens in a new window).
You can find out more information about IHT and pensions in HMRC’s IHT manual (link opens in a new window).
Do all pensions allow benefits to be paid by discretion?
No, some pension benefits are payable to the estate (unless a trust is set up). This is usually for products like Section 32s and retirement annuities (also known as section 226s) (link opens in a new window).
Care needs to be taken around certain death benefits paid from annuities (an annuity protection lump sum death benefit or a guaranteed period). Depending on how the annuity was set up these may be included in the estate for IHT purposes.
Can discretion be changed to direction?
Opting for discretion is a one-way street – once the decision is made, the individual can’t subsequently choose direction under that scheme. That’s because, if the inheritance tax treatment for discretion is to apply, HMRC say that direction can’t be available at any time under the scheme after discretion has been chosen.
The only way discretion can be changed to direction is if the individual transfers and choses direction under the new scheme. Care needs to be taken if the individual is in serious ill-health and does not survive more than two years as the transfer could be subject to inheritance tax. See our article on Direction for more detail on this.
Why should my client do a nomination form?
The nomination form (or expression of wishes) is used for two purposes.
- One is for the individual to tell the scheme administrator how they would like the death benefits to be split on their death.
- The other is so that they can nominate, or name, a beneficiary to receive nominee flexi-access drawdown (a ‘nominee’).
A scheme administrator can’t offer beneficiary drawdown to a beneficiary unless they’re a dependant, a nominee or a successor (link opens in a new window).
So not having a nomination (or having an out-of-date nomination) could result in potentially the wrong people being paid death benefits. Or the beneficiary(ies) not getting offered the option of beneficiary drawdown or an annuity.
If the individual wants non-dependent children to be given the option of flexi-access drawdown, they need to nominate them.
Most schemes provide a standard form to provide details of the individual’s beneficiary(ies).
What is a nominee or successor?
A nominee is an individual nominated by the member or the scheme administrator who is not a dependant. The scheme administrator can only nominate an individual where there is no surviving dependant, individual or charity nominated by the member.
A successor is an individual nominated by a dependant, nominee or successor of the member, or by the scheme administrator. The scheme administrator can only nominate an individual where there is no surviving individual or charity nominated by the beneficiary.
Should nominations be updated?
It is important to keep nominations up to date, as circumstances can change.
It is important 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 which may including flexi-access drawdown.
You should review nominations regularly; perhaps each time you see your client or each time you carry out their regular financial review.
Nominations can be updated at any time.
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, if a spouse predeceases the individual or if the spouse declines the benefits, no percentage is needed, they just need to be named. Although as much information as possible is always useful.
It’s worth noting that some providers insist on there being a percentage being used instead of nil percent.
If a 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, they will need to be nominated.
It’s worth remembering that it is the decision of the scheme administrator/trustee who benefits are paid to.
If an individual has been nominated by their parent on an expression of wish, can that individual request the death benefit be paid to their children (the deceased’s grandchildren) instead?
No, the beneficiary can refuse the pension benefits, but they cannot then direct the pension scheme where to pay their share. For example, the pension scheme could decide to split the beneficiary’s share between the beneficiary’s siblings (such the deceased’s other children) instead. The pension scheme may pay their share to the grandchild of the deceased, but this would only be once they have investigated the deceased’s family circumstances and decided that these were the best people to pay to.
The individual wants their spouse to receive beneficiary drawdown on their death and their children to receive successor’s drawdown on the spouse’s subsequent death. Is this possible?
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 they 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.
Can death benefits be paid to a charity?
A charity lump sum death benefit can be paid out from a money purchase arrangement but only where there are no dependants of the individual. See more here (link opens in a new window).
They will need to nominate the charity on their nomination form.
Can a Power of Attorney update a death benefit nomination for someone?
The Attorney can change the nomination, but they will need to ensure this is something they are allowed to do under the POA they have and, as per any decision they make on behalf of the individual (the ‘donor’), if must be in the donor’s best interest. If necessary, they will need to seek legal advice.
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.