This Focus is necessarily somewhat longer than usual. It holds a very important message for anyone who is a member of a pension scheme. It is based on our understanding of taxation matters that involve quite complex rules.
Money Purchase Pension Schemes – Death Benefits
As discussed in our October 2017 Focus (recent Focuses can be viewed from the “Articles” section of our website homepage), we … err … focused on the flexibility now available to Money Purchase Pension Scheme members when reviewing their retirement options. The importance of reviewing the structure and instructions of the associated death benefits remains as high as ever.
Indeed, not fully understanding the tax treatment of your pension death benefits, or of taking action that might have adverse consequences, or of not taking the appropriate action, in a worst case scenario could result in a 73% deduction of tax upon death (i.e. where pension death benefits are first subject to the Lifetime Allowance excess charge of 55% and then the remaining 45% becoming subject to a deduction of 40% Inheritance Tax (IHT).
Two key factors for Money Purchase Pensions death benefits are:
(*) On a scheme member’s death before age 75 the benefits could be paid as a drawdown pension or as a lump sum to any beneficiary potentially tax-free, irrespective of whether the pension benefits are derived from uncrystallised or crystallised monies (albeit for uncrystallised funds there is an assessment against the scheme member’s Lifetime Allowance which could result in a Lifetime Allowance excess charge).
(*) On death after age 75 the benefits could be drawn down or paid out as a lump sum taxed at the beneficiary’s marginal rate or paid as a lump sum to a trust but with a 45% tax charge.
The above two circumstances refer only to Income Tax and Lifetime Allowance excess charge situations – the key factor being whether death occurs before or after the member’s 75th birthday.
But then there is Inheritance Tax. Here there are two key considerations:
(*) Discretion – Does the pension scheme administrator/trustee have discretion over the payments of any death benefits?
If a money purchase pension member allows their scheme administrator to use their discretion when deciding who is to receive the death benefit from the pension arrangement, then this can mean that the value of the pension fund should not form part of the deceased’s estate for Inheritance Tax purposes.
(*) Two Year Window – Did death occur within two years of the pension scheme being established or of the funds being received into it?
An important caveat to the previous bullet point regarding Discretion and IHT is that if death occurs within two years of the pension benefits being established in the format they were held upon death, e.g. as a result of a pension transfer or certain other contributions, there can be some adverse consequence – the value of the benefits are likely to be included within the value of the deceased’s estate and therefore potentially liable to IHT. This is a complex area of planning and needs to be fully understood by anyone considering transferring a pension or certain other contributions, and particularly if considering doing so when in poor health.
Direction – or Discretion? That is the question!
If a Money Purchase Pension scheme member directs the pension scheme administrator as to exactly who should receive the lump sum death benefit from their plan without any scope for discretion by the administrator, and the scheme administrator can pay the lump sum death benefit in accordance with that direction, then the value of the death benefits could be counted as part of the estate for Inheritance Tax purposes on the member’s death.
Similarly if the scheme rules set out that death benefits are to be paid to the pension scheme member’s estate the same IHT fate will apply.
Generally speaking for newer schemes the default position is that the trustees and scheme administrators have discretion over the distribution of death benefits from a pension scheme. Many will not even accept direction. This is important as it means the benefits can usually be paid free of IHT. However, it is important, especially for older pension arrangements, that a scheme member confirms their pension is indeed established under this basis and then completes an Expression of Wish form.
Expression of Wish Form
An expression of wish form, although not binding on the scheme administrator/trustees, helps to guide them when exercising their discretion. As these nomination forms can usually be changed at any time, it is important that they are kept up-to-date and reflect the policyholder’s current wishes. The pension plan administrators/trustees will refer to the most recent Expression of Wish Form as part of their investigation as to who should receive the death benefits.
If a member dies without having set up an Expression of Wish, the trustees’ options may be limited as to how benefits can be paid because, when there is no Expression of Wish, trustees can only nominate dependants to receive benefits flexibly (i.e. not necessarily as a single lump sum), if there are indeed any dependants. Dependants could include a spouse or child under age 23 but may not automatically include older children for example. Anybody other than a dependant in this instance would have to receive any death benefits as a lump sum. It can be seen, therefore, that it is very important that pension plan policyholders revisit their nominated beneficiaries situation and complete an ‘Expression of Wish’ form to state to whom they wish this benefit to be paid. If an Expression of Wish is not completed then it is possible, in the worst case, that the monies could be added back into the deceased’s estate.
Always have in mind that current legislation revolves around the age of 75. The Expression of Wish form should be revisited regularly both prior to and after that trigger point to ensure that monies can be distributed in accordance with your wishes, in the context of any changes to family/beneficiary circumstances, and as tax efficiently as possible.
It also follows that the tax position of the beneficiary/beneficiaries, in particular their marginal rate of income tax, should also be taken into consideration in the context of a member’s death after the age of 75 and the payment of death benefits either as a draw down or as a lump sum – both being subject to that marginal rate.
Please do get in touch with your Financial Planner to ensure you are satisfied that you have an up to date expression of wish form in force with your pension provider – one that meets your current needs and wishes.
Defined Benefit (Final Salary) Pension Schemes – Death Benefits
It is very important to note that the death benefit rules of Defined Benefit (Final Salary) Pension Schemes are treated differently to those of Money Purchase Schemes.
Anyone who has accumulated Defined Benefit (Final Salary) pension benefits should review the death benefits associated with their particular scheme as scheme rules can vary widely.
We have set out above what is only a brief summary of some points that involve quite complex rules. Always take relevant professional advice before taking, or refraining from taking, any action.
Barry Fleming & Partners has grown from a tax advisory background into a broader business that encompasses investment management. Both things matter for wealth management, retention and creation. That expertise makes the company strikingly different from others.
This capability allows Barry Fleming and Partners to use its strength in tax advice to take a 360-degree-view of a financial situation to give much broader, more comprehensive advice.
We bring together up to the minute tax, estate, investment and retirement planning advice to create individual, ‘joined up’ financial strategies. This allows our clients to understand and have confidence in how they can best control, retain, and build their assets and income to achieve their objectives with least risk.
A high level of service is key to our long-term client relationships. We work collaboratively. That means our clients can benefit at all times from having ready access to our team of financial planners.
Barry Fleming & Partners are an independent financial advisor specialising in ISA’s, Pensions, Tax, Trusts, Estate Planning, Inheritance Tax Planning (IHT) and other Financial Planning areas. Please don’t hesitate to call on 01488 608 686 and ask to talk to one of our financial advisors. Alternatively use the contact form on our home page.