Death benefits FAQs

Here's some questions that have been regularly asked since the pension flexibility changes were introduced on 6 April 2015. These FAQ are for financial advisers only. They mustn’t be distributed to, or relied on by, customers. They are based on our understanding of current legislation, which may change.

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For many years pilot trusts (often referred to as spousal bypass trusts, as they’re commonly used for this purpose) have been a popular destination for pension lump sum death benefits, subsequently allowing the trustees (including a spouse) to have control in accessing and distributing the pension funds at their discretion without actually adding the  funds to a spouse’s estate and causing a possible IHT problem further down the line. The new death benefit flexibility now available, in particular the ability to pass funds down the generations within a tax-advantaged registered pension scheme, will likely mean that pilot trusts are less popular in future and in some cases may be redundant.

Clients with existing pilot trusts may wish to regularly review their continued suitability in the run up to age 75 and beyond in view of the new pension death benefit flexibility. If the trust is no longer suitable the client can change their death benefit nomination in favour of other beneficiaries and the trustees can exercise their powers to distribute the nominal amount used to create the trust to one or more of the beneficiaries, leaving the trust with no value.

That’s not to say pilot trusts should be completely disregarded however. Even though the funds held in a pilot trust are subject to the discretionary trust tax rules and therefore possibly subject to IHT periodic and exit charges, there are still many examples where such a trust could still be appropriate as an alternative to keeping pension benefits within a registered pension scheme. For example if there is a wish to have much more control in how assets are used, if there are complex family relationships, where the proposed beneficiaries are minors, and so on. For cases where a pilot trust is appropriate, Aegon offers a draft trust that covers our full range of pension products. The pilot trust document, with its own guide and nomination form is available on our website and from your usual Aegon contact.

While it is not possible to offer any guarantees regarding IHT, generally speaking if the scheme administrator exercises its discretionary powers to allocate the uncrystallised and/or remaining drawdown funds to a non-dependant beneficiary for the choices of drawdown, annuity and lump sum, it will normally be free of any IHT liability.

A lump sum death benefit paid to the trustees of a pilot trust will be paid tax free if the individual in respect of whom the funds have arisen died before age 75, and the lump sum is paid within two years of the scheme becoming aware of the death. If it is paid outwith the two-year period, it will be subject to a special lump sum death benefit charge of 45%. This tax charge remains at 45% from 6 April 2016 as payment is being made to a trust.

If the individual in respect of whom the funds have arisen died on or after age 75, any lump sum paid to the trustees of a pilot trust will be subject to a special lump sum death benefit charge of 45%. Again, this tax charge remains at 45% from 6 April 2016 as payment is being made to a trust.  

It is the age at death of the dependant, nominee or successor, as the case may be, who is passing on the drawdown funds that is relevant for the purposes of determining the tax rate applicable to the death benefits, not the age at which the original member died.

In the circumstances described, any lump sum or income chosen would be free of income tax as the nominee died before the age of 75.

Depending on the scheme, it may be possible in these circumstances to delay payment of a lump sum death benefit until after 5 April 2016 when the applicable tax rate on such lump sum payments changes to the marginal tax rate of the recipient if paid to a ‘qualifying person’. Broadly, a qualifying person is an individual, other than:

  • an individual acting in the capacity of trustee (excluding a bare trustee),
  • a director of a corporate body,
  • a partner of a partnership, or
  • a member of a limited liability partnership

Any lump sum paid in relation to the death of an individual on or after age 75 to a non-qualifying person (for example, to the trustees of a pilot trust) will continue to be subject to a special lump sum death benefit charge of 45%.

Any lump sum death benefit paid from uncrystallised funds on the death of the member before age 75 will be tested against the deceased member’s available lifetime allowance provided it is paid within two years of the scheme first becoming aware of the member’s death. Any excess will be taxed (in the hands of the recipient) at the rate of 55%.

Since 6 April 2015, any uncrystallised funds used on the death of the original member before age 75 to provide income to a dependant and/or nominee will also be tested against the deceased member’s available lifetime allowance, provided they are used within two years of the scheme first having become aware of the member’s death. If the value of the uncrystallised funds being used to provide income to beneficiaries exceeds the deceased member’s available lifetime allowance, and the funds are used within two years of the scheme first having become aware of the member’s death, the recipient(s) will be liable for the lifetime allowance charge on the excess amount at the rate of 25%.

If the original member dies after age 75, or dies before age 75 but the benefit is paid outwith the two-year period, there will be no benefit crystallisation event.