Death benefits pre-6 April 2015 overview

The rules applying to death benefit provision changed dramatically on 6 April 2015.  This article details the rules prior to that date.
Key points

There were a number of factors which affected death benefit provision on the member's death. These included:

  • whether or not the member was in receipt of their benefits when they died
  • the type of pension the member was in receipt of (if applicable)
  • the age of the member at date of death

HMRC had a definition of the word 'dependant' and an individual must meet this in order to be paid a dependants pension.

If the member died after taking their benefits or after the age of 75, there was a tax charge of 55% on any lump sum death benefits paid.

Inheritance tax was not usually payable on lump sum death benefits but, where the scheme administrator had no discretion over the payment, there may have been a liability.

For information on the current treatment of death benefits see our article Death benefits from April 2015.

This analysis focuses on death benefits both before and after retirement and the range of options available under each situation.

What options are actually available will of course depend on the rules of the relevant pension scheme.

Options... at a glance

Generally speaking, there were two options available to beneficiaries on the member's death.

Click on a heading below to learn more:

Whilst there was, in theory, no limit on the amount of lump sum death benefit that could have been provided under a registered pension scheme, the scheme rules still determined what could actually have been paid out in terms of death benefits. For example scheme rules could allow four times salary as a lump sum death benefit or simply a return of fund. It's important to note that a tax charge would have applied to any lump sum death benefit payable in excess of :  

  • the standard lifetime allowance (SLA), or
  • the personal lifetime allowance (PLA) if primary protection had been chosen, or
  • the 'benefits value' (for example the fund value) if enhanced protection had been chosen, or
  • the fixed lifetime allowance if fixed protection 2012 or fixed protection 2014 had been chosen, or
  • protected lifetime allowance if individual protection 2014 had been chosen

This tax charge, known as the 'lifetime allowance charge', was applied to any excess lump sum death benefit over relevant lifetime allowance value at a rate of 55%, payable by the recipient of the lump sum.

Any fund in excess of the relevant lifetime allowance could be used to provide dependants' pensions without having to pay the charge.

If the member was younger than 75 at date of death, there was not normally any liability to inheritance tax (IHT) so long as the trustees decided who the lump sum was to be paid to and the lump sum death benefits were not paid to the deceased member's estate.

If the member was 75 or over at date of death, the whole lump sum was subject to a 55% tax charge. IHT would not have been payable in addition to this charge, even where the scheme administrator did not decide who to pay the benefits to.

Dependants pensions were not tested against the deceased's or recipient's lifetime allowance, and could be paid on top of any lump sum death benefit. This meant that the value of any benefits above the deceased's lifetime allowance could be used to provide dependants' pensions. If all excess benefits were used in this way the lifetime allowance charge could have been avoided.

In order to be paid a dependant's pension for life, individuals still needed to qualify as 'dependants'. This includes:

  • legally married spouse or civil partner
  • unmarried partner (a 'common-law' husband or wife or someone of the same sex) can be treated as a dependant, where the relationship was one of financial dependence on the member or financial interdependence
  • children - under the age of 23 or older in the case of dependency due to mental or physical incapacity
  • ex-spouse if they were married to the member when they first started to take the pension, and
  • any other person that the scheme administrator considered dependent on the deceased at the time of death due to physical or mental impairment, or financial dependency or that there was financial interdependence between that person and the member

Different options for different scenarios...

Although the options available to the beneficiaries generally fell into one of the above categories, the actual options depended on the member's circumstances at the time they die.

The following four scenarios show the options that were available to the beneficiaries, depending on the age of the member when they died and whether or not they had taken their retirement benefits.

Click on a scenario to see the options available to the beneficiaries, and click on an option for further details.

Member died before taking their benefits and under the age of 75

The options that were available to the beneficiaries are shown below. Click on a heading to learn more.

Whilst there was, in theory, no limit on the amount of lump sum death benefit that could have been provided under a registered pension scheme, the scheme rules still determined what can actually be paid out in terms of death benefits. For example scheme rules could allow four times salary as a lump sum death benefit or simply a return of fund. It's important to note that a tax charge would have applied to any lump sum death benefit payable in excess of :

  • the standard lifetime allowance (SLA), or
  • the personal lifetime allowance (PLA) if primary protection had been chosen, or
  • the 'benefits value' (for example the fund value) if enhanced protection had been chosen, or
  • the fixed lifetime allowance if fixed protection 2012 or fixed protection 2014 had been chosen, or
  • protected lifetime allowance if individual protection 2014 had been chosen

This tax charge, known as the 'lifetime allowance charge', was applied to any excess lump sum death benefit over relevant lifetime allowance value at a rate of 55%, payable by the recipient of the lump sum.

Any fund in excess of the relevant lifetime allowance could be used to provide dependants' pensions without having to pay the charge.

So long as the scheme administrator decided who the lump sum death benefit was to be paid to, there was no IHT liability.

Dependant's income could have been secured in two ways. Either by:

  • buying a dependant's scheme pension, or
  • buying a dependant's lifetime annuity

Defined benefit schemes could only offer a dependant's scheme pension. Also, money purchase schemes had to offer an open market option if income was to be secured by an annuity.

Dependant's scheme pension A scheme pension may be provided under both a defined benefit or a money purchase scheme. To be a scheme pension the pension:

  • had to be paid for the life of the dependant
  • had to be paid at least annually
  • could not be capable of being reduced year on year, and
  • had to be paid by the scheme administrator or by an insurance company chosen by the scheme administrator

Dependant's lifetime annuity Only a money purchase scheme could provide a dependant's lifetime annuity. To meet the lifetime annuity definition the annuity contract must:

  • have been purchased from an insurance company of the dependant's choice
  • have been payable for life
  • have been paid at least once a year, either in advance or in arrears
  • have stayed level or increase
  • not have allowed the payment of a capital sum triggered by the dependant's death, apart from annuity protection, and
  • not have been capable of being assigned or surrendered, unless there was a pension sharing order

Dependant's income could have been paid in two ways. Either by:

  • income drawdown, or
  • short-term annuities

Dependant's income drawdown (ID) The minimum income under dependant's income drawdown (ID) was 0% and the maximum income was 150% of the relevant Government Actuary's Department (GAD) single life annuity rate with no guarantee. Any level of income could have been selected between these limits but this had to be reassessed every 3 years (then every year from age 75). A dependant could request a review at the end of each pension year. The scheme administrator could grant or refuse this request at their discretion. Our article on Income drawdown and review dates provides more information.

Should the dependant die under ID any remaining fund not used to provide income could be paid as a lump sum subject to a 55% tax charge. No IHT would have been payable in addition.

Short-term annuities Short-term annuities allow a dependant to buy an annuity, or a series of annuities (on the open market, if required), with all or part of their fund. The annuity term could not have been for more than 5 years.

Member died before taking their benefits and over the age of 75

The options that were available to the beneficiaries are shown below. Click on a heading to learn more.

Whilst there was, in theory, no limit on the amount of lump sum death benefit that could have been provided under a registered pension scheme, the scheme rules still determined what could actually be paid out in terms of death benefits. For example scheme rules could allow four times salary as a lump sum death benefit or simply a return of fund. The lump sum death benefit was not tested against the lifetime allowance.

As the member was 75 or over at date of death, the whole lump sum was subject to a 55% tax charge.

Dependant's income could be secured in two ways. Either by:

  • buying a dependant's scheme pension, or
  • buying a dependant's lifetime annuity

Defined benefit schemes could only offer a dependant's scheme pension. Also, money purchase schemes had to offer open market options if income was secured by an annuity.

Dependant's scheme pension A scheme pension may be provided under both a defined benefit or a money purchase scheme. To be a scheme pension the pension:

  • had to be paid for the life of the dependant
  • had to be paid at least annually
  • could not be capable of being reduced year on year
  • had to be paid by the scheme administrator or by an insurance company chosen by the scheme administrator

Dependant's lifetime annuity Only a money purchase scheme could provide a lifetime annuity. To meet the lifetime annuity definition the annuity contract must:

  • have been purchased from an insurance company of the dependant's choice
  • have been payable for life
  • have been paid at least once a year, either in advance or in arrears
  • have stayed level or increase
  • not have allowed the payment of a capital sum triggered by the dependant's death, apart from annuity protection, and
  • had not been capable of being assigned or surrendered, unless there was a pension sharing order

Dependant's income could be paid in two ways. Either by:

  • dependant's income drawdown, or
  • dependant's short-term annuities

Dependant's income drawdown (ID) The minimum income under income drawdown (ID) was 0% and the maximum income was 150% of the relevant Government Actuary's Department (GAD) single life annuity rate with no guarantee. Any level of income could have been selected between these limits but this must have been reassessed every 3 years (then every year from age 75). A dependant could request a review at the end of each pension year. The scheme administrator could grant or refuse this request at their discretion. Our article on Income drawdown and review dates provides more information.

Should the dependant die under ID any remaining fund not used to provide income could be paid as a lump sum subject to a 55% tax charge. No IHT would have been payable in addition.

Short-term annuities Short-term annuities allowed a dependant to buy an annuity, or a series of annuities (on the open market, if required), with all or part of their fund. The annuity term could not be more than 5 years.

Member died after taking their benefits and under the age of 75

The death benefit situation after benefits had been crystallised depended on the way in which benefits were taken. Click on a heading to learn more.

Where a secured pension was used to crystallise benefits the options available to a deceased's dependants were as follows:

  • if the annuity was purchased with an attaching dependants pension this would have been payable for the remainder of the dependant's life, or
  • if the annuity was purchased with a guarantee period (maximum 10 years) pension instalments will continue until the end of any guaranteed period, or
  • pension protection - a lump sum death benefit payment based on the difference between the annuity purchase price when secured pension was selected and the income payments made to date of death taxed at 55%

Where a capped drawdown pension was used to crystallise benefits the options available to the deceased's dependants were as follows:

  • continue income drawdown, or
  • buy dependant's short term annuities, or
  • buy a dependant's lifetime annuity, or
  • any remaining fund not used to provide income can be paid as a lump sum subject to a 55% tax charge

Member died after taking their benefits and over the age of 75

The death benefit situation after benefits had been crystallised depended on the way in which benefits were taken. Click on a heading to learn more. 

Where a secured pension was used to crystallise benefits the options available to a deceased's dependants are as follows:

  • if the annuity was purchased with an attaching dependants pension this would be payable for the remainder of the dependant's life, or
  • if the annuity was purchased with a guarantee period (maximum 10 years) pension instalments will continue until the end of any guaranteed period, or
  • pension protection - a lump sum death benefit payment based on the difference between the annuity purchase price when secured pension was selected and the income payments made to date of death taxed at 55%.

Where a capped drawdown pension was used to crystallise benefits the options available to the deceased's dependants are as follows:

  • continue income drawdown, or
  • buy dependant's short term annuities, or
  • buy a dependant's lifetime annuity, or
  • any remaining fund not used to provide income can be paid as a lump sum subject to a 55% tax charge.

A couple of points worth bearing in mind...

If there were no dependants it may have been possible to pay a charity lump sum death benefit, though certain conditions apply.

Dependants pensions did not have a tax-free cash option.

Note

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.

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Last updated: 20 Nov 2014

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The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm is on the Financial Services Register, registration number 117672. It provides life assurance and pensions. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London, EC3V 0RL.