Explaining the 2024 pension death benefit rules

The case:

Abigail is aged 63. She has a SIPP worth £1,200,000. She has not yet accessed the pension and she doesn’t have any lifetime allowance protection.

She is married to Pete. They have a daughter, Chloe, who is 25, and is financially independent.

Abigail is worried about dying in her 60s and wants to explore what will happen to her pension benefits if that happens. She needs a cash lump sum of £100,000 in February 2024, and intends to take this from her SIPP.

The prescription:

Abigail’s adviser explains the pension tax rules are changing in April 2024. The lifetime allowance is being abolished and replaced with:

• a lump sum allowance of usually £268,275, limiting the total amount of tax-free cash someone can take in their lifetime from their pension through PCLS and the tax-free part of any UFPLS; and
• a lump sum and death benefit allowance of usually £1,073,100, limiting the total amount of tax-free cash someone can receive in their life, including any tax-free serious ill health lump sums, plus the tax-free lump sums their beneficiaries can receive on their death.

If in February 2024 Abigail takes £100,000 tax-free cash from her SIPP she will use up 37.27% of the lifetime allowance under the current rules. £300,000 will move to drawdown, leaving £800,000 untouched.

If Abigail then dies at 66 before taking any other pension benefits, her two allowances will be reduced by the amount of lifetime allowance already used:

• Lump sum allowance = £268,275 – 25% of (37.27% of £1,073,100) = £168,288
• • Lump sum and death benefit allowance = £1,073,100 – 25% of (37.27% of £1,073,100) = £973,114

Let’s say when Abigail dies her uncrystallised pension is worth £850,000 and her drawdown pension is worth £310,000.

If Abigail doesn’t nominate anyone, Pete, who is a dependant, will be the sole beneficiary. He will have the choice of taking drawdown or a lump sum. If he chooses to take a lump sum, then, as Abigail died under age 75 and assuming he takes the benefits within two years, he can take a tax-free amount of up to Abigail’s remaining lump sum and death benefit allowance.

When testing the benefits against the lump sum and death benefit allowance, any drawdown funds set up before April 2024 are ignored. Only the uncrystallised amount of £850,000 is tested against £973,114. Therefore there is no excess.

Taking benefits after April 2024

However, if Abigail took £100,000 cash out of her pension in May – instead of February – her lump sum allowance would be reduced by that exact amount to £168,275 and her lump sum and death benefit allowance would be reduced to £973,100.

When she dies both her uncrystallised pension of £850,000 and her post-24 drawdown fund of £310,000 would be tested against that allowance.

That leaves an excess of £186,900 (£973,100 – £850,000 – £310,000).

If Pete took the pension benefits as a lump sum, he would have to pay income tax on that amount.

Drawdown instead of lump sum

However, Pete could take the pension benefits as drawdown rather than a lump sum. If he did then there wouldn’t be any test against the lump sum and death benefit allowance, and no income tax to pay (assuming he takes the benefits within two years).

Pete would then have the flexibility to take as much as he wanted out of the drawdown plan.

Nomination form

Pete can choose either a lump sum or drawdown as he is a beneficiary through being a dependant. If he decides he doesn’t need the pension benefits and wants Chloe to receive them instead, then as Abigail didn’t nominate Chloe to receive her pension benefits (and she’s not a dependant), Chloe could only take a lump sum, and, in the example above, pay income tax.

However, if Abigail nominates Chloe, she will also have the option to take drawdown meaning she won’t pay any tax.