Death benefit planning

So we are now two years into the pension freedoms regime and the statistics are starting to emerge and interpretations, both positive and negative, are being formulated.

The area we will not see so much detail on is the death benefit regime and the planning opportunities the pension freedoms offer.

I am often reluctant to put estate planning issues above lifetime income issues but they are part and parcel of the new regime - perhaps somewhat surprising at inception but, on reflection, a real encouragement to save.

In general, prior to the new flexi-access drawdown rules, the ability to carry on with income drawdown on the death of the original pension holder was restricted to a ‘Dependant’ (in this context ‘Dependant’ is a defined term covering the spouse or civil partner of the member, a child under age 23, or a person who was financially dependent, mutually financially dependent or otherwise reliant on the member due to physical or mental impairment). Alternatively, a lump sum could be paid to a trust, charity or other nominated beneficiary.

The new flexi-access drawdown rules allow three possible types of beneficiary to be able to access drawdown after the death of the scheme member. So, as well as the Dependant, there are now other options:

  • A ‘Nominee of a member’ – an individual nominated by the member or nominated by the scheme administrator, but only in the absence of any Dependant of the member or member nomination.
  • A ‘Successor of a member’ – an individual nominated by a Dependant or Nominee of the member (in relation to their own death) or nominated by the scheme administrator but only where the beneficiary has not made a nomination.

In my opinion, it is the Successor that is the slightly odd option. In the past everything emanated from the person who accrued the benefit but now the deceased’s Dependant or Nominee can nominate a Successor and it could be someone who had absolutely no connection with the original pension scheme member.

This flexibility can be important if the preferred beneficiaries do not fit into the definition of a Dependant and with modern family structures and increasing longevity, this is often the case. Many of the enquiries I get are about cases where pension scheme members have grown up children to whom they would like to pass on any surplus funds.

So, on death of the pension scheme member before age 75, benefits can be paid to the appropriate beneficiary free of tax. (NB it is important to make sure that the benefit is designated/paid within two years. If after this period then the benefits will be taxed at a marginal rate if paid to an individual or there will be a special lump sum death benefit charge of 45% if the benefit is paid as a lump sum to a trust.)

It is in the situation where death occurs after age 75 that the extended definitions can really assist in the planning process. On death after age 75 the benefits will normally be taxed at the marginal rate of the recipient, therefore the key to efficient planning will be to nominate the benefit to a recipient who is paying the lowest rate of tax.

For example, bypassing grown up children who could be higher rate tax payers to nominate grandchildren, who can draw down up to their nil rate band without tax, could be a very efficient way of passing money to assist for university expenses.

The fact that this flexibility is not available on defined benefit (DB) pension schemes makes it a key feature for consideration in the DB transfer process (with everything else)!

Head of Platform Technical

Mike Morrison has worked in financial services for far too many years. In 1990 he joined Winterthur (now AXAWealth) as Technical Manager, playing an instrumental role in the development of their SIPP product and later their pioneering work on income drawdown.

Mike is an ex Chairman of AMPS (the Association of Member Directed Pension Schemes) and is on the Financial Planning Committee of the ICAEW. He is also an Associate of the Pensions Management Institute and the Chartered Insurance Institute, and he holds both an LLB and an LLM in European Law.

An accomplished speaker and writer on financial services matters, Mike is passionate about retirement and savings issues, and how we can better communicate these to a wider audience.