The importance of reviewing beneficiaries

There is no doubt that the biggest pension topic I had to deal with last year was the new death benefits rules and the ability to use them for IHT and estate planning.

In discussing the new rules, the importance of reviewing the expression of wish/nomination form has been to the fore. In other words, making sure that the right beneficiary has been nominated.

I was with one adviser recently and he advised me that two of the first cases that he had reviewed had the client’s ex-spouse as the nominated beneficiary and had not been updated since the divorce.

The new rules make it important to consider the potential beneficiaries should the individual die before the age of 75, and then again to revisit the situation should the individual live beyond that magic age.

It is clear now that in order to offer flexi-access drawdown in an income form there must be a nominee, otherwise it has to be paid out as a lump sum. And there can be serious tax consequence of getting it wrong.

Consider the case of a non-taxpaying grandchild who could draw up to the personal allowance free of tax each year if nominated, or would be taxed on the whole sum if not nominated.

It is important to realise that such nominations should not be binding. If they were, it could defeat the trustee discretion, resulting in the unwanted outcome of the death benefits becoming subject to IHT.

HMRC has confirmed that lump sum death benefits fall within the estate where:

  • the payment is made to the estate as of right
  • there is a binding nomination made by the deceased that the payment is to be made to specified beneficiaries
  • for deaths before 6 April 2012, in certain circumstances, the payment includes protected rights

Spouse or civil partner exemption is available where appropriate when the payment is part of the estate.

HMRC has also confirmed that the nomination of a dependant, nominee, or successor by a pension scheme member or beneficiary will not cause them to be treated as making a transfer of value for Inheritance Tax purposes on death, as long as the member/beneficiary does not have power under the scheme’s rules to irrevocably choose the beneficiary and that the scheme trustee or administrator has a discretionary power to choose who should receive death benefits.

There has been a lot of talk of moral hazard in the new pension rules and this could well be the backstop to protect the pension holder from themselves!

Elaborate I know, but imagine the scenario – I have a bit of a mid life crisis and frivolously take up with a very friendly Russian cocktail waitress. In my haste I nominate her to receive my pension death benefits. I then unfortunately die and the evidence put to the trustees indicates my folly and that in reality the benefits should be paid to my destitute wife and six dependent children.

I guess we then move on to the concept of Trustee discretion, how it is exercised and whether it can be challenged.

There are legal authorities on the extent and application of trustee discretion.

One such case is Edge v Pensions Ombudsman (Court of Appeal) 1999. This case made it clear that Trustees can favour some beneficiaries over others, as long as the decision to do so is made properly.

Interestingly, it is also authority for the fact that other quasi-legal bodies such as the Pensions Ombudsman should not try to second guess the trustee’s decision and that, unless it can be seen as obviously unreasonable, the decision of the trustee should not be challenged.

It is okay having legal authorities but a really useful pointer on this subject came from the Pension Ombudsman himself in an interview reported in one of the trade magazines in 2015.

From his own words we got some very useful guidance as to how trustee discretion can operate.

"They have to make sure their decision isn't so out of kilter that no other reasonable body of trustees would have made it... There is quite a margin they have to exercise their discretion."

He also comments on death benefits, recognising that trustees may have to go a bit further than the member's expression of wish form, especially if that form was signed a long time ago.

"Say you have an expression of wish form saying ‘I want to leave all this to my dear wife' that was signed in 1995. You need to make sure they were still living together, you need to ask a few questions. Quite often somebody has written that expression of wish form, forgotten all about it, got divorced, moved in with someone else, had some children with them - the whole thing can be very complicated."

In essence the trustees have to make sure the right tests have been applied, that they have considered the relevant factors and they have discounted irrelevant factors.

"They just have to apply common sense. They don't necessarily have to agree with the individual, they have to look at the facts they have got and ensure they are making a decision within a range of decisions that a reasonable body of trustees would have made."

From an Ombudsman’s perspective, it is not their job to question a properly exercised trustee’s decision but it is important to make sure the process is followed appropriately. An interesting case on this point was the Pension Ombudsman determination (Barnicoat (PO-5763): Death Benefits). The claim was that the decision to exercise discretion was not done in a timely manner thus causing financial loss, but the Ombudsman found against the claimant.

I am sure there will be more decisions that are contested and there will be new ‘no win, no fee opportunities’, meaning that pension trustees/administrators must we aware of their duties and have a robust procedure for dealing with them.

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.