Synopsis: Proposed amendments to the Taxation of Pensions Bill give an outline of how death benefits under money purchase registered pension schemes will be taxed when pensions flexibility is introduced.
In the summer of 2014, the Government released draft clauses for the Taxation of Pensions Bill 2014. The legislation deals with the taxation of pension benefits under the pension flexibility rules and will come into effect on 6th April 2015.
At the Conservative Party conference at the end of September, the Chancellor announced that the ‘death tax’ on pension funds was to be relaxed and it would be easier for individuals to pass their pension funds to beneficiaries on death. The Taxation of Pensions Bill was published on 21st October 2014 but, other than the rate of tax payable, did not deal, in detail, with the taxation of death benefits or who may benefit. The detail/fine print of the death benefit changes were announced on 6th November 2014 via Amendments to the Taxation of Pensions Bill at the Public Bill committee stage of the parliamentary process.
The most important amendment concerns the payment of death benefits when the pension fund continues in drawdown after the member’s death. Provision is now made for individuals other than ‘dependants’ to inherit unused drawdown funds. In this respect, the Bill introduces the concept of Nominee and Successor beneficiaries. The new legislation will mean that any individual can inherit unused drawdown funds or uncrystallised money purchase funds on the death of the member, where those funds are used to provide a drawdown pension or pay a lump sum death benefit.
In order to enable somebody who is not a dependant to benefit from the drawdown funds, there will be a new Nominee’s flexi-access drawdown fund. In addition any beneficiary (that is, a dependant or a nominee) with unused drawdown funds on their death can pass those funds to a successor to be designated to provide a drawdown pension for that individual (a successor’s flexi-access drawdown fund) or to be paid as a lump sum death benefit.
Death benefits from funds in flexi access drawdown can continue to be payable in the form of a lump sum or as part of income drawdown and subject to certain conditions being met, these payments can be tax free.
How can death benefits be paid by a money purchase registered pension scheme from 6 April 2015?
On the death of the Member, death benefits can be paid either as a lump sum or be retained in the pension fund and be taken as income drawdown.
On the death of the person entitled to drawdown, it will be possible for either drawdown to continue to another beneficiary or for a lump sum to be paid.
(i) Payment of lump sum on death of member
Here the pension scheme Trustees/Scheme Administrator will typically exercise their discretion in favour of one of a discretionary class. If the member was under 75 and the payment is made within 2 years of the date of the members’ death, it will be tax free. If the member was over age 75, the lump sum will be taxed at 45%.
The requirement for certain lump sums death benefits to be paid as authorised payments within a two-year period will be removed.
(ii) Retained as drawdown
On the member’s death, the pension fund can be designated to a flexi access drawdown account. Here the person entitled to continue to drawdown will be either
• Dependant (as current rules)
• Nominee
Where the death of the member occurred before age 75, any payments of income drawdown to the dependant or nominee can be made tax free provided the funds are designated to the drawdown account within a two-year period, subject to the member having sufficient lifetime allowance
Where the designation is not made within two years, or the member had reached age 75 at the time of their death, all payments of drawdown pension will be subject to the recipient’s marginal rate, but will not be tested against the lifetime allowance.
What is a nominee?
For someone that is not a dependant, there will be a new category of recipient, a Nominee who can benefit from a drawdown account. A nominee is an individual that has been nominated by the member or the Scheme Administrator but who is not a dependant of the member. There are circumstances where the Scheme Administrator can and cannot make a nomination but a Scheme Administrator cannot name a Nominee whilst there is a dependant of the member.
What is a successor?
A successor can inherit the pension fund on the death of a dependant, a nominee or previous successor. The successor can be nominated by either the dependant, the successor of the member or the Scheme Administrator.
On the death of the member of a money purchase pension scheme, the funds can be used to provide benefits to a dependant and/ or a nominee. . On the death of the dependant or nominee, a successor can inherit the funds, and this can be passed on through the generations until the funds are exhausted either because they are all taken as income or a lump sum is paid out, thereby extinguishing the fund.
What lump sum death benefits can be paid where a member dies before age 75 and death benefits are paid out after 5 April 2014?
• Uncrystallised funds lump sum death benefit
• Capped drawdown funds lump sum death benefit
• Flexi access drawdown fund lump sum death benefit
• A Charity lump sum death benefit (only payable in specific circumstances)
If a lump sum is paid by the trustees/scheme administrator exercising their discretion in favour of a beneficiary, it will not be subject to tax if:
• it is paid within 2 years of the member’s death (or the date the Scheme Administrator ought to have known of the death) and
• the deceased member has sufficient available lifetime allowance.
If any of the funds are in excess of the member’s Lifetime Allowance then that portion will be subject to a lifetime allowance charge.
How can death benefits be paid as income drawdown to beneficiaries on the death of the member before age 75?
Instead of paying a lump sum on the death of the scheme member, the fund can continue to be held in or designated to flexi-access drawdown. Payments can continue to be made to beneficiaries as Dependants/Nominee flexi access drawdown
If income is taken via flexi access drawdown, the income is not subject to income tax providing that the funds are designated within a two year period. Dependant’s lifetime annuities will continue to be taxable on the recipient.
What form of lump sum death benefit can be payable where the member dies on or after age 75?
The following type of lump sum death benefit can be paid:-
• Uncrystallised funds lump sum death benefit
• Capped drawdown funds lump sum death benefit
• Flexi access drawdown fund lump sum death benefit
• Charity Lump sum death benefit (only payable in specific circumstances)
If the pension scheme member (dependant, nominee or successor), dies aged 75 or more, the appropriate lump sum payment will be subject to the special lump sum death benefits charge (45% from 6/4/15). There is no 2 year rule applying to these lump sum payments.
If the fund remains in drawdown and the appropriate beneficiary takes income drawdown, this will be taxable at the recipient’s marginal rate(s).
What happens on the death of a beneficiary (ie. a dependant, nominee or successor) who is entitled to flexi-access drawdown?
The remaining fund can be paid as a lump sum (a flexi-access drawdown fund lump sum death benefit) or a new beneficiary can continue in drawdown. If a lump sum is paid, it will in general be tax free if the deceased beneficiary was aged under 75 when he died and the payment is made within 2 years of the deceased beneficiary’s death.
If payments are made under income drawdown they will be taxed at the recipient’s marginal rate of income tax if the previous deceased beneficiary died at age 75 or more.
Tax treatment of death benefits paid after 5 April 2015 following the member’s death
| Death benefit | Tax | LTA CHECK | |
| Death of member before age 75 | |||
| Lump Sum | Tax free | Yes BCE 7 if from uncrystallised and no if from crystallised funds | |
| LS – Not paid out within 2 years: | 45% | ||
| Flexi access drawdown (2) | Tax free if designated within 2 years | Yes, BCE 5C if paid from uncrystallised funds | |
| Lifetime annuity | Taxed at recipients marginal rate(s) | No |
| Death of a member at age 75 or later | |||
| Lump sum | 45% (2015/16)(possibly moving to marginal rate after consultation) | No | |
| Flexi access drawdown (2) | Taxed at recipient’s marginal rate(s) | No | |
| Lifetime annuity | Taxed at recipients marginal rate(s) | No |
1) Or within 2 years of the Scheme Administrator reasonably knowing of the death.
2) Lump sums paid on the death of a dependant, nominee or successor (a ‘beneficiary’) would normally be free of tax if:
(a) the deceased beneficiary died before age 75 and
(b) the payment is made within 2 years of the pension beneficiary’s death.
We will publish a further Bulletin shortly analysing these changes in even more detail.
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