The importance of keeping death benefit nominations up-to-date

Life is what happens while we are making other plans.

It’s a well-worn saying, but has more than a grain of truth. Personal circumstances change all the time, and in different ways. Clients may get married, have children, get divorced, get re-married, have more children, and grandchildren may or may not arrive on the scene.

As the saying alludes to, this can happen at a rate of knots, and your carefully-laid plans can easily go out of the window. But while it’s entirely a client’s prerogative to simply take life as it comes, financial planners need to have an eye on the future at all times.

This is especially true when there are changes to legislation, as there too often are, particularly in the domain of pensions. And when it comes to pensions death benefits, it pays to ensure that death benefit nominations match up with what’s going on in the real world.

The first and most obvious thing to say is to revisit any death benefit nominations in your annual conversations with clients. And if they mention important life events like those in the first paragraph, it could be a good opportunity for an ad-hoc review. Both of these conversations can be good springboards into other areas of planning, and it may help build relationships.

There are also technical aspects to consider as well. Since the introduction of the pensions freedoms rules in April 2015, death benefits are largely free from tax if the client dies before age 75. However, they will usually be subject to tax at the beneficiary’s marginal rate if the client dies from 75 onwards.

Death benefits can be paid out in the form of a lump sum or in the form of a pension. Lump sums can be paid to anyone. However, only certain types of beneficiary can receive a pension, these being ‘dependants’, ‘nominees’ and ‘successors’.

The full technical definition goes wider than this, but a dependant is typically a spouse or civil partner of the client, or a child of the client under the age of 23. A nominee is a beneficiary who has been nominated by the client on a death benefit nomination. A successor is a beneficiary who has been nominated by a dependant or nominee.

In some cases, it can be more tax-efficient for a beneficiary to receive a pension than a lump sum, and this is one reason why it’s important to review nominations, especially from age 75.

Case study

Felicity has a SIPP and dies aged 82. She is survived by her husband Andrew, also 82. They have two adult children Caitlin and Kirsten. Caitlin has two teenage children of her own. Kirsten has one. Felicity’s nomination with her SIPP provider says Andrew 50%, Caitlin 25% and Kirsten 25%.

Felicity was over 75, so the death benefits will be taxable. Andrew and Caitlin are higher rate taxpayers. Kirsten is a basic rate taxpayer. Andrew qualifies as a dependant as he was married to Felicity, while Caitlin and Kirsten qualify as nominees given that they were on the death benefit nomination.

When it comes to distributing the death benefits, the provider speaks to Felicity’s personal representatives. Andrew has a pension of his own and is receiving the bulk of Felicity’s estate, so he is well catered for. Caitlin and Kirsten both have solid jobs.

In any event, Andrew, Caitlin and Kirsten are all in agreement that they would like a sizeable chunk of Felicity’s SIPP to go to the grandchildren in the form of pensions.

This makes sense from a planning perspective. Given that the grandchildren are not likely to be taxpayers for around ten years, they could receive income tax-free from the pensions up to the personal allowance of £11,500. In fact, if managed carefully, they might never pay any tax on the pensions at all, and the funds would be ideal for when they go to university.

Looking at the technicalities, however, the grandchildren don’t qualify as nominees given that they weren’t on the death benefit nomination. This means the pension option isn’t open to them. The scheme administrator of the SIPP could still opt to pay them a lump sum, but the whole lump sum would be taxed.

Looking back, Felicity could’ve updated her nomination form when she turned 75 and added her grandchildren to receive a nominal amount, say 1%. This would’ve been sufficient to bring them into the definition of nominee, and they could’ve received a pension effectively tax-free.

The bottom line is that there is a lot of cultural wisdom in sayings, but when it comes to financial planning, this one’s best ignored, as ten minutes of planning could save thousands in tax.

Technical Team Leader

After completing his postgraduate studies at Lancaster University, Martin spent two years working for a leading insurance company before joining AJ Bell in April 2007. Martin worked initially on the AJ Bell Investcentre product before moving to a technical role in 2009. His main focus is providing technical support to the various teams and departments within the business. He is also involved in delivering training to staff on the rules and regulations that affect our customers.