MANY pension schemes pay
benefits following a member’s
death. This could be a lump sum, a
pension paid to a dependant or a
mixture of both.
The type and amount of benefit
paid normally depends on if you die
before or after starting your pension.
The provision of death benefits
within pension schemes can often be
quite
complex.
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.
Who can receive a lump sum
death benefit from a pension
scheme?
Unlike survivors’ pensions, payment of
lump sum death benefits is not limited
to just dependants of the deceased
member. So, for example, lump sum
death benefits could also be paid to
other family members, a trust set up
by the deceased member, friends, the
deceased member’s estate or a charity.
Different lump sum death benefit
rules apply depending on whether
they’re paid from uncrystallised rights
or crystallised rights. Your pension
benefits are uncrystallised where no
tax-free cash has been paid and they
become crystallised when a tax-free
cash lump sum has been paid to the
member.
What sources can provide
lump sum death benefits
under a pension scheme?
The types of lump sum death benefit
that can be paid from a registered
pension scheme and the sources they
can come from depend on whether the
deceased member’s benefits had been
crystallised or not.
If they have been crystallised it will affect how the pension benefits are
being paid.
• Uncrystallised rights
Lump sum death benefits can be paid
from uncrystallised rights within two
years of the member’s death.
Lump sum death benefits paid
from uncrystallised rights on the
member’s death prior to age 75 are paid tax free, so long as they are paid
within two years of the scheme
administrator becoming aware of the
death and within the deceased
member’s available lifetime allowance.
Lump sum payments made outside
the two-year time limit will normally
be treated as unauthorised payments
subject to unauthorised payment tax
charges of up to 70%. Any lump sum
above the deceased member’s available
lifetime allowance will face a 55%
lifetime allowance tax charge.
• Crystallised rights or benefits on
death after age 75
Lump sum death benefits from
crystallised rights depend on how the
pension benefits are being paid.
A lump sum payment is available
from a value protected annuity or a
defined benefit pension.
A return of the remaining
drawdown fund is available on death
during income drawdown. This was
originally only available on death
before age 75. But since 6th April
2011, the lump sum can be paid after
age 75 from funds in drawdown or
from “unused funds”.
There’s no fixed time limit for
paying these lump sum death benefits.
The tax treatments from
crystallised rights are broadly as
follows: on death in income
drawdown, or on death after age 75
with “unused funds”, a 55% tax charge
(the special lump sum death benefits
tax charge) will be taken off any lump
sum death benefits paid.
Any lump sum death benefits paid
from crystallised rights with value
protection will also be subject to the
55% tax charge. A lump sum can be
paid tax free to a nominated charity if
certain conditions are met.
Lump sum death benefits
from a pension scheme and
the lifetime allowance
This depends on whether the lump
sum is provided from uncrystallised or
crystallised rights.
Any lump sum death benefit paid
from uncrystallised rights must be
tested against the deceased member’s
available lifetime allowance. Any lump
sum above this will face a 55%
lifetime allowance tax charge.
Payment of lump sum death
benefits from crystallised rights isn’t a
benefit crystallisation event, because
these rights have already been tested
against the deceased member’s lifetime
allowance when they were originally
brought into payment, or at age 75. So
there’s no further lifetime allowance
test.
Survivor’s pensions
In order to avoid the payment of the
special lump sum death benefits tax charge it may be
possible to have a
survivor’s pension paid
in preference to a lump
sum. The survivor’s
pension will be taxed
as earned income on
the recipient.
The payment of a
survivor’s pension
following the death of
the member isn’t a
benefit crystallisation
event. So these benefits aren’t tested
against the lifetime allowance of either
the deceased member or the survivor
being granted the pension.
• Who can receive a survivor’s
pension from a pension scheme?
Survivors’ pensions from a registered
pension scheme can be paid to any
dependant. Dependant means the
deceased member’s widow(er) or civil
partner, children under age 23 (unless
the child is dependent because of
physical or mental impairment), or
anyone else who in the opinion of the
scheme administrator was in some way
dependent on the member at the time of death, such as unmarried partners
or disabled relatives.
Survivors’ pensions can be paid to
one or more of the deceased
member’s dependants.
Survivors’ pensions can be paid
via income drawdown, lifetime
annuities or scheme pensions. The
options in any particular case will
depend on the circumstances and
what the particular pension scheme
allows.
Survivors’ pensions paid to
children must normally stop at age 23;
however, there are a few exceptions to
this rule. Other survivors’ pensions
will usually continue for life, although
widow(er)s’ or civil partners’ pensions
can be paid on the basis that they’ll
stop on remarriage.
It’s not possible to attach another
survivor’s pension or pension
guarantee period to a survivor’s
pension.
• Can a survivor’s
pension from a
pension scheme be
deferred?
Yes, it doesn’t have
to come into payment
with effect from the
date of the member’s
death. This may be an
attractive option in
some circumstances: for example, if there’s
a young widow(er) who is still working or where there are
continuing guaranteed pension
payments. However, whether a
survivor’s pension entitlement can be
deferred in this way, and for how
long, will depend on the terms of the
scheme rules or the wording of the
relevant annuity contract.
As can be seen above, it is crucial
to recognise that a decision to take
some or all of your pension benefits
will significantly change the tax
treatment of the funds on death.
Therefore, it is always worth seeking
professional advice before signing up
to anything.
