Here we will look at the common options that are available under current regulations. We must emphasise that not all options are permitted under these regulations. For example, a pension plan taken out in 2005 might not offer Drawdown options. The options that are permitted will depend entirely on the rules of the pension.
Prior to 6 April 2015, the death benefits that could be paid were determined by whether the pension funds were crystallised, or uncrystallised. Crucially, since 6 April 2015, it is now the age of the individual on death that will adjudge the tax treatment of the pension benefits. The distinction between crystallised and uncrystallised is no longer prevalent; however, a lifetime allowance test applies to uncrystallised pension benefits.
Firstly, let's take a look at the key facts of Pension Drawdown arrangements:
- On death, before age 75, the benefits can be paid as a lump-sum, or as a drawdown pension to a chosen beneficiary/beneficiaries free from tax, regardless of whether they emanate from uncrystallised to crystallised funds
- Conversely, death after age 75, the benefits can be drawn, or paid as a lump-sum, taxed at the marginal rate of the beneficiary
- Moreover, on death after age 75, the benefits can be paid as a lump-sum to a trust with a 4% tax charge
The constraint that pension income can only be paid to a ‘dependant’ no longer applies. Where an individual has been nominated as a ‘beneficiary’ by the policy-holder, they can receive pension benefits. Subsequently, any named beneficiary can elect to take an income (including in the form of drawdown) as well as a lump-sum. One advantage of a beneficiary taking drawdown is that on their death, any remaining funds may be passed on to further nominated beneficiaries. In theory, this makes it possible to continue passing on the pension fund until it is eventually depleted.
When a pension scheme member dies, the scheme administrator has to pay the death benefits to someone. The process of choosing who the beneficiary/beneficiaries is/are can either involve the scheme administrator/trustees exercising their discretion, or the scheme member determining this prior to their death, using a Nomination of Beneficiaries form. Ultimately, the choice can affect the inheritance tax (IHT) payable on the benefits.
Let's take a look at several scenarios that will bring the key points of this article to life:
If a 70-year-old policyholder dies whilst being a member of a drawdown pension - could their 82-year-old friend (Anne), who is the named beneficiary, carry on taking income tax-free?
The answer is ‘yes’. As the policyholder died before age 75, the benefits can be paid to Anne tax-free, regardless of whether they were derived from uncrystallised or crystallised money.
If Anne, subsequently dies while in receipt of the pension income – could any remaining pension funds be passed on to a further (nominated) beneficiary?
The excess fund would be passed to any named beneficiary. If Anne had not nominated a beneficiary, it would be down to the scheme administrator/trustee to use their discretion to determine who should receive the excess funds, as a lump-sum. As Anne was over the age of 75 when she died, any nominated beneficiary would receive the pension income payments, or a lump-sum, after tax at their marginal rate of tax.
On Anne’s death, the pension drawdown fund passed to George, her son. As he did not need the pension money, George wanted to pass it on to his daughter, so he left the funds in drawdown, without taking any income. What would happen on George’s death?
If George died before age 75, the pension fund could be passed to his daughter tax-free, as either a lump-sum, or as a pension income. If George died after age 75, the lump-sum or income would be taxed at his daughter’s marginal rate of tax.
If you are unsure about the flexibility of your pension and the death benefits that it provides, our Consultants are available to discuss your options in your detail.