The changes to pensions death benefits that were introduced from April 2015 under pension freedoms have given pension plan members and their beneficiaries a generous range of options in respect of who can benefit from a pension and how they can take the money.
One of the key changes was that the pension plan member is able to nominate any beneficiary to receive the payments from the pension, either lump sum or income/annuity payment. However, there are differing tax considerations for the beneficiary depending on the age of the pension plan member when they die.
On death before the age of 75 all withdrawals and payments to the beneficiary will be made free of tax. The nominated person can take the benefits as they choose either as a lump sum or as regular or flexible income.
On death after the age of 75, payments to the beneficiary will be subject to income tax at their marginal rate.
In addition, new rules also allow the nominated beneficiary in turn to pass on any unused pension funds on their death to their own nominated beneficiary, known as a successor. The same tax treatment applies but the relevant age will be the age of death of the beneficiary rather than the original member. If the beneficiary dies before age 75 the successor can receive a tax free lump sum or a drawdown pension tax free. If the beneficiary dies at age 75 or over, then any benefits can either be taken by the successor as taxable drawdown income or a lump sum, currently taxed at the recipient’s marginal rate of income tax.
Funds within a pension are normally exempt from Inheritance Tax. This gives the potential to pass pension funds down through the generations without ever falling into anyone’s estate for inheritance tax (IHT) purposes.
Pension death benefit options
Pre age 75
• Tax free lump sum
• Tax free income via drawdown
• Beneficiary’s annuity free of tax
Age 75 or over
• Drawdown income taxed at beneficiary’s marginal rate
• Lump sum payment taxed at beneficiary’s marginal rate
• Beneficiary’s annuity taxed
Alongside having a will, one of the most important things for people to do is make clear who they want their pension benefits to go to. How you do this will differ depending on the type of pension plan.
Pension scheme trustees have discretion over who death benefits can be paid to. You can guide them by stating your instructions using their ‘Expression of Wish’ form, or death benefit nomination form. However, under the new pension freedoms there are generally a wider range of potential beneficiaries for personal pensions and SIPPs, than in DB schemes. DB schemes usually restrict benefits to classes of beneficiaries, which may not be in accordance with your personal wishes.
Finally, it should be noted that not all pension plans allow the full range of pension freedoms for savers and their beneficiaries.