Helping pension trustees exercise their discretion on death

One of the many requirements of a pension trustee is to use their discretion to decide who should benefit from a deceased member’s pension fund. The pension death benefit rules are undeniably generous, and many a wealthy client will use pensions as a key part of their inheritance tax planning strategy.

Whilst we have sweeping changes to the pension regime from the start of this new tax year, relatively little has changed when it comes to death benefits. When the member dies before their 75th birthday, beneficiaries who opt to take the death benefits as a pension income can take an unlimited amount tax free. Where the funds are paid out as a lump sum, they are tax-free up to the deceased’s available lump sum and death benefit allowance.

On death on or after the 75th birthday the death benefits will be subject to income tax, but if this is kept within a pension then the beneficiary can still benefit from the tax wrapper for an indefinite period and manage withdrawals within tax bands as appropriate.

The big plus of course is that pensions are usually outside the estate, so escape the inheritance tax net. This prompts the behaviour of drawing on other assets first for retirement income and keeping pensions until last.

All of this is only possible because of trustee discretion. If a pension scheme were to allow binding nominations, then the death benefits would fall into the estate. Whilst this isn’t likely to be an issue if the benefits are going to the spouse, it would be in many other cases. And I’ve seen enough cases where nominations were made to the surviving spouse, but they’ve asked for it to be waived in favour of their children, as they are financially secure in their own right.

However, exercising this discretion can be a tricky business. Trustees should consider relevant factors and ignore irrelevant information that interested parties may put forward. There are no right or wrong decisions, but decisions should be reasonable. All too often we see out-of-date nominations where members have re-married, divorced, separated, have new partners and / or had more children, without updating them. And then there are also the cases where there’s no nomination at all. All of this means the decision is more complex, and inevitably takes longer for benefits to be distributed.

In an ideal world there would be a carve out for pensions that allowed them to be distributed by the executors in line with the rest of the estate, but without the IHT bill. In the meantime, it is important to make sure your clients update their pension nomination when their circumstances change, so when the time comes the process is as straightforward as possible.