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Keeping it in the family

3 months ago

Pension freedoms brought major changes to the options available for paying pension death benefits from defined contribution (DC) schemes. These changes introduced a great deal of flexibility and opened up new avenues for intergenerational planning, but they do add further choices at a time where clients are often most vulnerable. This article outlines how a pension can be passed down through generations and some of the key planning points to keep in mind.

How it works

Thanks to changes introduced from 6 April 2015, more people than ever can now choose to receive death benefits in the form of a pension. Individuals must be either a dependant, a nominee or a successor to qualify.

A dependant is someone who is either:

  • The spouse or civil partner of the member at the date of the member’s death (or, if the scheme rules allow, was a spouse or civil partner of the member when the member first become entitled to a pension under the scheme); or
  • A child of the member aged under 23, or older and dependent due to physical or mental impairment; or
  • Anyone who was not a spouse, civil partner, or child of the member, but who was otherwise dependent on the member due to:
    • Financial dependence
    • Mutual financial
    • Physical or mental impairment

Nominees are simply someone nominated as a beneficiary of the member’s pension. Anyone can be nominated – they don’t have to be related to or dependent on the member. A successor is someone nominated by an existing beneficiary to inherit a beneficiary’s drawdown pot.

After the member of a DC scheme has died, there are different ways in which death benefits can be paid – most often a lump sum, annuity, or flexi-access drawdown. However, only a beneficiary’s drawdown pension can be repeatedly passed down to successors without leaving the pension wrapper.

The benefits

As only dependants, nominees and successors can receive a beneficiary’s drawdown pension, if your clients want this flexibility to be available to their loved ones they should provide a nomination to their scheme and keep this updated.

By retaining the money in the pension wrapper, the funds continue to benefit from the usual tax advantages of a pension. These include keeping the money out of the recipient’s estate, and allowing investments to benefit from tax-free growth. The beneficiary chooses when to access the inherited funds and can do so at any time. They’re not required to take an income immediately, so there is potential to retain and grow the funds until needed.

An important point to consider is whether any income drawn will be taxable. Prior to 6 April 2015 only dependants could receive death benefits in the form of a pension, and all income drawn was subject to Income Tax. However, if the dependant didn’t draw any income until after 6 April 2015, then as long as the deceased member dies under age 75 income can now be taken tax-free.

Since 6 April 2015, following the death of the member death benefits are only subject to Income Tax if the member dies aged 75 or over, or if they weren’t designated within the relevant two-year period.

After a beneficiary’s death, death benefits will be subject to Income Tax if the beneficiary (not the original member) was aged 75 or over. This means the tax treatment of the funds can change as they are passed on to successors.

A benefit crystallisation event (BCE) will occur when death benefits are first designated following the original member’s death, if they haven’t previously been tested in the deceased’s lifetime. This tests the funds against the deceased member’s lifetime allowance. There is never a test against the beneficiary’s lifetime allowance, and there won’t be any subsequent BCEs on the fund even when passed on to successors. This is particularly helpful if the beneficiary or subsequent successors already have substantial pension savings.

Other considerations

Ultimately the beneficiary’s personal circumstances dictate the best option for them. They may have an immediate need for a lump sum, or prefer the guaranteed income afforded by an annuity. These factors may trump the desire to pass on a pension to their loved ones.

As beneficiary’s drawdown can be accessed at any age, even if the beneficiary is under 18, the issue of control should be considered. It may also be a factor in complex family situations, perhaps due to divorce or remarriage. Some clients may prefer to nominate a trust to receive death benefits as a lump sum, rather than an individual, so there is more certainty over who ultimately benefits and when.

Lastly, not all schemes offer beneficiary’s drawdown. It is often possible for DC schemes to nominally designate benefits to beneficiary’s drawdown and then transfer them to another provider who can facilitate payments. This isn’t onerous, but should be checked with the original scheme, as it is at their decision.

This article was previously published by Professional Adviser

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Bethany Joslyn

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Technical Consultant

Beth joined AJ Bell in 2013 and has over ten years’ experience in the financial services industry. She has previously worked in Client Services and Customer Relations, and joined the Technical Team in 2019. Beth provides technical support to various teams within the business and is involved in designing and delivering technical training to staff. In 2021 she completed the CII Diploma in Financial Planning.

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