Question: What's the difference between direction and discretion when it comes to paying out pension scheme lump sum death benefits?
Answer: 40% inheritance tax1
Planholders have two options:
They can allow the pension scheme administrator/trustees to use discretion when deciding who should receive the lump sum death benefit from their pension arrangement. This usually means the value won't be counted as part of their estate for inheritance tax on their death.
They can tell the scheme administrator/trustees exactly who should receive the lump sum death benefit from their plan. The scheme administrator/trustees will pay the lump sum death benefit in accordance with the direction. The value of the death benefits will normally be counted as part of the estate for inheritance tax on their death.
Still not clear? Then let's look at each option in more detail:
If the scheme administrator/trustees are asked to use their discretion when paying lump sum death benefits, they will take into account the planholder's wishes; however they aren't bound by their request.
When the scheme administrator/trustees are told of someone's death, they will review the most recent nomination but may choose not to follow the planholder's wishes if circumstances have changed, for example:
When the scheme administrator/trustees are asked to use their discretion in this way, HMRC considers this a 'letter of wishes', which normally means the lump sum death benefit will be free of inheritance tax.
Opting for discretion is a one-off decision and if the scheme administrator/trustees are asked to use discretion, the planholder can't change their mind and opt to for direction later.
The planholder can instead choose to direct the scheme administrator/trustees and tell them who they want to receive the lump sum on their death. In this case the scheme administrator/trustees must comply with the planholder's direction even if their circumstances have changed.
The value of the death benefits will normally be counted as part of the estate for inheritance tax on their death.
It's important to note that the planholder can change their mind and ask the scheme administrator/trustees to pay the pension lump sum death benefit at their discretion instead of at their direction; they can do this by letting the scheme administrator/trustees know.
The diagram below illustrates James Smith's journey from the point he takes out his pension plan. After choosing option 1 or option 2, he makes changes to his nominated beneficiaries as his circumstances change.
Download a copy of our 'Payment of benefits on death' nomination form.
It is important to keep nominations up to date, especially if the planholder has directed who is to receive the benefits, as circumstances can change.
It's therefore worth reviewing nominations regularly; perhaps each time you see your client or each time you carry out their regular financial review.
The planholder can update their nominations at any time.
1 If a planholder dies and leaves at least 10% of their net estate to charity, the inheritance tax rate that applies is reduced to 36%.
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.