Death benefits

These FAQs are for financial advisers only. They must not be distributed to, or relied on by, customers. They are based on our understanding of legislation, at the date of publication.

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Registered pension schemes can pay a variety of benefits on the death of a member and on the subsequent death of a dependant, nominee or successor. The type of benefit that can be paid will depend on whether the payment is from uncrystallised or crystallised funds. It will also depend on the type of pension arrangement the member’s benefits are held in, the scheme rules or the product’s terms and conditions.

These FAQs cover the death benefits that are allowable under the legislation, from registered money purchase pension schemes. They don’t cover the death benefit rules for defined benefit schemes, nor do they cover the treatment of contracted-out benefits (GMP and Reference Scheme Test benefits).

The death benefit rules changed on 6 April 2015, and further small changes were made on 6 April 2016. The table below shows what can currently be paid when a member dies:

Benefit type Payment type

Member dies before age 75 with uncrystallised rights

The beneficiary can:

  • Take an uncrystallised funds lump sum death benefit – the amount of lump sum up to the limit of the member’s remaining lifetime allowance is paid tax-free. Any excess will be subject to a tax charge 1, or
  • Take tax-free income from flexi-access drawdown 2, or
  • Buy an annuity or scheme pension with payment paid tax free2&3

Member dies aged 75 or over with uncrystallised rights

The beneficiary can:

  • Take an uncrystallised funds lump sum death benefit which is taxable at their marginal rate of tax 4, or
  • Take income from flexi-access drawdown, which is taxable at the recipient’s marginal rate of tax, or
  • Buy an annuity or scheme pension which is taxed at the recipient’s marginal rate of tax

1A lump sum death benefit will only be paid tax-free if it’s paid within a two year period. In addition, uncrystallised funds are only tested against the member’s remaining lifetime allowance if they are paid within the same two year period. See ‘What is the two year rule for uncrystallised funds?’ for more information.

2New benefit crystallisation events were introduced from 6 April 2016 to test any remaining uncrystallised funds used to provide dependant’s or nominee’s drawdown or to buy a dependant’s or nominee’s annuity, where the member was under age 75 at death.  These are BCE5c and BCE5d respectively. See ‘Are death benefits tested against the lifetime allowance?’ for more information.

3Where the member died on or after 3 December 2014 and no payment of the annuity was made before 6 April 2015. The two year rule also applies here – see ‘What is the two year rule for uncrystallised funds?’ for more information.

4 If the beneficiary is a non-qualifying person, the lump sum is taxed at 45%. See ‘What is a ‘non-qualifying person’?’ for more information.

Lump sum payments can be made to a wide range of beneficiaries, who don’t necessarily have to be dependants of the member (although scheme rules may restrict this to a narrower range of people). Flexi-access drawdown and annuities can be set up for dependants, nominees or successors of the member. See ‘Who can be a dependant, a nominee or a successor?’ for more information.

The death benefit rules changed on 6 April 2015, and further small changes were made on 6 April 2016. The table below shows what can currently be paid when a member dies with drawdown funds remaining:

Benefit type Payment type

Member dies before age 75, with drawdown funds remaining

The beneficiary can:

  • Take a tax-free drawdown pension fund lump sum death benefit1, or
  • Take tax-free income from flexi-access drawdown, or
  • Buy an annuity which will be paid tax free2

Member dies aged 75 or over with drawdown funds remaining

The beneficiary can:

  • Take a drawdown pension fund lump sum death benefit which is taxable at their marginal rate of tax3, or
  • Take income from flexi-access drawdown taxed at their marginal rate, or
  • Buy an annuity taxed at their marginal rate

1A lump sum death benefit will only be paid tax-free if it’s paid within a two year period. See ‘What is the two year rule for drawdown funds?’ for more information.

2Where the member died on or after 3 December 2014 and no payment of the annuity was made before 6 April 2015.

3If the beneficiary is a non-qualifying person, the lump sum is taxed at 45%. See ‘What is a ‘non-qualifying person’?’ for more information.

Lump sum payments can be made to a wide range of beneficiaries, who don’t necessarily have to be dependants of the member (although scheme rules may restrict this to a narrower range of people). Flexi-access drawdown and annuities can be set up for dependants, nominees or successors of the member. See ‘Who can be a dependant, a nominee or a successor?’ for more information.

Changes to death benefits payable from annuities came into force on 6 April 2015. The table below shows the options:

Benefit type Payment made on or after 6 April 2016

Continuing annuity, individual dies before age 75

Any beneficiary1 can receive payments tax free, if the member died on or after 3 December 2014

Continuing annuity, individual dies on or after 75

Any beneficiary1 can receive the payments at their marginal rate of tax

Guaranteed term annuity, individual dies before age 75

Any beneficiary1 can receive payments tax free, if the member died on or after 3 December 2014 and no payment is made before 6 April 20152

Guaranteed term annuity, individual dies on or after 75

Any beneficiary1 can receive payments at their marginal rate of tax2

Annuity protection lump sum death benefit, individual dies before 75

Any beneficiary1 can receive payments tax free

Annuity protection lump sum death benefit, individual dies on or after age 75

Marginal rate tax paid if paid to an individual, or 45% if paid to a non-qualifying person3

1 A beneficiary can be a dependant, a nominee or a successor. See ‘Who can be a dependant, nominee or successor?’ for more information.

2 If the remaining instalments under a guarantee term are £30,000 or less, they can be paid as a trivial commutation lump sum death benefit. It’s worth noting that where in individual dies before age 75 while still in a guarantee period, income payments made to a beneficiary will be tax free if the relevant conditions above are met, but if those benefits are commuted, the lump sum will be taxed at the recipient’s marginal rate. See ‘Trivial Commutation Lump Sum Death Benefits’ for more information.

3 See ‘What is a non-qualifying person?’ for more information.

Since 6 April 2015, a trivial commutation lump sum death benefit can be paid to a dependant instead of a small dependant’s pension if the value of that pension is not more than £30,000, or to an individual where the remaining instalments under a guaranteed period are valued at not more than £30,000. This £30,000 limit applies to each registered pension scheme in its own right – it’s not an overall limit.

In order to pay a trivial commutation lump sum death benefit to a dependant or individual, it must be paid to the dependant who is entitled to the annuity or the individual who is entitled to the remaining instalments under the guaranteed period, and the payment must extinguish the dependant’s/individual’s entitlement to pension or lump sum death benefits under the scheme.

Trivial commutation lump sum death benefits can be paid whatever the age of the member at death. The full lump sum payment will be taxed as income at the dependant’s/individual’s marginal rate of tax. If the provider doesn’t have a tax code to operate against the payment, tax will be deducted at basic rate, which may result in too much tax being paid. The dependant/individual can claim a refund of any overpaid tax, by completing a P53 form (either online or using a paper form). There is no time limit for making the payment. The dependant’s pension or remainder payable under a guarantee can be commuted at any time.

Payment of a trivial commutation lump sum death benefit is not a benefit crystallisation event.

Lump sum death benefits

Any payment of a lump sum death benefit made after the end of a two year period, which starts on the date the scheme administrator was first notified of the member’s death (or on the date that the scheme administrator could first have reasonably known of the member’s death, if earlier) is classed as an uncrystallised funds lump sum death benefit and will be subject to the Special Lump Sum Death Benefit Charge. 

The Special Lump Sum Death Benefit Charge was 45% for lump sum death benefits paid between 6 April 2015 and 5 April 2016. 

From 6 April 2016, payment of a lump sum death benefit outside of the two year period where the member died before age 75, will be taxed depending on who the recipient is.

If it is paid to someone in an individual capacity the lump sum will be taxed as income on that individual at their marginal rate.

If it is paid to a ‘non-qualifying person’ (see ‘What is a non-qualifying person’ for more information) the payment is not treated as their income for tax purposes. Instead the scheme administrator is liable for the Special Lump Sum Death Benefit Charge at 45%, which they will normally deduct before paying the lump sum death benefit. 

Beneficiaries’ annuity

If an individual dies on or after 3 December 2014 and before the age of 75 with uncrystallised funds remaining, any payment of a dependant’s or nominee’s annuity bought with these funds will be paid tax-free, if:

  • the entitlement to the beneficiary’s annuity arose within two years of the date the scheme administrator was first notified of the member’s death or the date the scheme administrator could first have reasonably known of the member’s death, if earlier, and
  • the first payment is made on or after 6 April 2015. 

If the beneficiary becomes entitled to the annuity outside of the two year period, the full annuity payment will be taxable at the recipient’s marginal rate, even if some of it is bought with unused drawdown funds belonging to the deceased member (an annuity bought with unused drawdown funds only is not subject to the two year rule and therefore would be paid tax free if the other conditions are met).

Note - payments from a successor’s annuity will be tax free if the conditions below are met:

  • it is paid in respect of a deceased member of a registered pension scheme (regardless of the member’s age at the date of death)
  • it’s paid on the subsequent death of a dependant, nominee or successor of the member (the beneficiary)
  • the beneficiary in respect of whom it’s paid died before age 75, on or after 3 December 2014
  • the annuity is bought with undrawn funds
  • the first payment is made on or after 6 April 2015

The two year rule doesn’t apply to successors annuities.

Since 6 April 2015, any payment of a drawdown lump sum death benefit after the end of the two year period, starting on the earliest of:

  • the date the scheme administrator was first notified of the member’s death, or
  • the date the scheme administrator could first have reasonably known of the member’s death

is subject to the Special Lump Sum Death Benefit Charge, where the member dies before age 75.

Where the payment of the drawdown lump sum death benefit was made between 6 April 2015 and 5 April 2016, the scheme administrator was liable to pay the Special Lump Sum Death Benefit Charge of 45%. This would usually have been deducted by the scheme administrator before paying out the lump sum.

From 6 April 2016, payment of a drawdown lump sum death benefit outside of the two year period where the member died before age 75, will be taxed depending on who the recipient is.

If it is paid to someone in an individual capacity the lump sum will be taxed as income on that individual at their marginal rate.

If it is paid to a ‘non-qualifying person’ (see ‘What is a non-qualifying person’ for more information) the payment is not treated as their income for tax purposes. Instead the scheme administrator is liable for the Special Lump Sum Death Benefit Charge at 45%, which they will normally deduct before paying the lump sum death benefit.

This means that lump sum death benefits paid from drawdown funds where the member, dependant, nominee or successor died before age 75 will only be tax free if it’s paid within this two year period.

Dependants

Dependant means:

  • The member’s spouse or civil partner at the date of the member’s death (or, if scheme rules allow, at the date the member first became entitled to a pension entitlement under the scheme)
  • Any child of the member under the age of 23 when the member dies1
  • Any child of the member over the age of 23 who, in the opinion of the scheme administrator, is dependent on the member because of physical or mental impairment
  • Anyone who isn’t married to the member, isn’t a civil partner of the member or isn’t a child of the member, but in the opinion of the scheme administrator, was financially dependent on, or inter-dependent with, the member at the member’s date of death (for example, an unmarried partner).

1Until 15 September 2016, the child of a member ceased to be classed as a dependant when they reached age 23, unless in the opinion of the scheme administrator, at the date of death they were dependant on the member because of physical or mental impairment.

The Finance Act 2016 (which received Royal Assent on 15 September) brought in a change to this, from the day after Royal Assent, i.e. 16 September 2016.

The change has the effect of removing the age 23 restriction for the purposes of allowing a deceased member’s child to continue in flexi-access drawdown or capped drawdown beyond the age of 23. Before this amendment, any income paid after the child reached age 23 was an unauthorised payment.

This change only applies where the child in question reaches age 23 on or after 16 September 2016. If the child reached age 23 before 16 September, any income paid from the capped or flexi-access dependant’s drawdown beyond age 23 will continue to be an unauthorised payment.

Note: this amendment does not affect the definition of a child as a dependant for the purposes of securing a dependant’s annuity or providing a dependant’s scheme pension (the dependant’s pension must stop when the child reaches age 23, unless they can still be classed as dependent as a result of mental or physical impairment). Nor will it affect the meaning of ‘nominee’ – i.e. a nominee of the member or the scheme administrator can be any individual, but not a dependant (so a child under age 23 can’t be a nominee (assuming no physical or mental impairment) but a child aged 23 or over can). Finally, it doesn’t affect the definition of a dependant for the purposes of paying a charity lump sum death benefit (see ‘What is a charity lump sum death benefit’ for more information). Where the member has nominated a charity to receive a lump sum, this can’t take effect if there is a dependant of the member – the age 23 restriction will continue to apply here.

Nominees and successors

Changes to who can receive drawdown income or annuities from death benefits when a member dies were made on 6 April 2015. Prior to that date, income from death benefits could only be paid to a dependant of the member. Since 6 April 2015 pension death benefits can be paid to dependants, ‘nominees’ and ‘successors’.

A nominee can be any individual other than a dependant, who is nominated by the member (or where there are no dependants and where no individual or charity has been nominated by the member, any individual nominated by the scheme administrator). 

A successor is an individual who inherits any unused drawdown funds (but not uncrystallised funds) on the death of a dependant, a nominee or another successor. Successors are individuals (who can also be dependants of the member) who have been nominated by a dependant, nominee or successor of the member, or if no nomination has been made, nominated by the scheme administrator. Note – members can’t nominate successors.

There is no limit on the number of successors who can benefit from unused drawdown funds. This means it’s possible to pass unused drawdown funds through multiple generations when dependants, nominees or previous successors die.

For example, Joan dies with unused flexi-access drawdown funds. Before her death she nominated her younger brother, Robert, as a ‘nominee’. When Joan dies, Robert can either:

  • Take a lump sum death benefit
  • Use the unused drawdown fund to purchase an annuity
  • Use the unused drawdown fund for nominee’s drawdown.

Robert chooses the third option and decides to pass the funds onto the next generation of his family, so he nominates his son as a ‘successor’. When Robert dies, his son can choose from the same options that Robert had. If he decides to designate the funds into successor’s drawdown in his own name he can then choose whether to take income, leave the funds invested until a future date or pass them on to the next generation of his family, in the same way that his dad did.

Both nominee’s and successor’s drawdown must be flexi-access and can be paid either as:

  • Nominee’s/successor’s income withdrawal, or
  • Nominee’s/successor’s short-term annuity

Funds can be designated to nominee’s drawdown from the deceased member’s capped or flexi-access drawdown fund, or from any uncrystallised funds remaining on death.

The position is similar for successor’s drawdown except that it isn’t possible to designate uncrystallised funds into a successor’s drawdown fund – only unused crystallised funds can be applied to a successor’s drawdown fund.

A non-qualifying person in relation to payment of a lump sum death benefit is:

  • A person who is not an individual, or
  • A person who is an individual, and the payment is being made to them in their capacity as:
    • A trustee (but not a bare trustee)
    • A personal representative
    • A director of a company
    • A partner in a firm, or
    • A member of a Limited Liability Partnership.

Where a lump sum death benefit is subject to a Special Lump Sum Death Benefit tax charge and is paid to a non-qualifying person in their capacity as a trustee, if they pay any part of the lump sum as a settlement to a beneficiary, the gross amount of the lump sum (so before the 45% tax charge) will be treated as income of the beneficiary for income tax purposes. However, the beneficiary can claim a reduction in their tax charge to take account of the 45% tax charge paid by the trust. See this website for more information:

https://www.gov.uk/trusts-taxes/beneficiaries-paying-and-reclaiming-tax-on-trusts

BCE7 - lump sum death benefits paid from uncrystallised funds where the member died before age 75 are tested against the lifetime allowance, so long as they’re paid within the relevant two year period (See ‘What is the two year rule for uncrystallised funds’ for more information). 

Two new benefit crystallisation events were introduced on 6 April 2015 to test the deceased member’s remaining uncrystallised funds against their available lifetime allowance, where the uncrystallised funds are designated to provide dependant’s or nominee’s flexi-access drawdown, or to purchase a dependant’s or nominee’s annuity. 

BCE5C - where an individual dies before age 75 and their uncrystallised funds are designated into dependant’s or nominee’s flexi-access drawdown within the two year period, the amount designated is tested as a BCE5C against the deceased individual’s available lifetime allowance. 

BCE5D (effective where the entitlement to the annuity arises on or after 6 April 2015) - where a member dies on or after 3 December 2014 and before age 75, and their uncrystallised funds are used within the relevant two year period to purchase a dependant’s or nominee’s annuity, the purchase price of the annuity is tested as a BCE5D against the deceased member’s available lifetime allowance. 

If a lifetime allowance charge is due, the dependant/nominee is liable for it.

Note - if the payment of the uncrystallised funds lump sum death benefit or the designation into dependant’s or nominee’s flexi-access drawdown or purchase of a dependant’s or nominee’s annuity doesn’t take place until after the end of the two year period, there is no test against the lifetime allowance (BCE7, BCE5C or BCE5D, respectively, do not take place) but the lump sum or income will be taxable at the recipient’s marginal rate of tax, regardless of the fact that the member died before age 75.

If no individual trust is in place on a member’s policy, scheme rules will generally provide that any lump sum death benefit is payable at the discretion of the scheme administrator/trustees. The scheme administrator/trustees will decide who is to receive the lump sum from the list of beneficiaries in the scheme rules.

Common beneficiaries are the member’s spouse, civil partner and other dependants but can also be charities, trusts and legal personal representatives.

Where the scheme administrators or trustees have the power to make a discretionary decision, the lump sum will not form part of the deceased member’s estate for IHT purposes. This applies whether the lump sum is paid to one or more beneficiaries, or to the estate.

Scheme rules usually allow the member to nominate, in writing, who they would like to receive the lump sum death benefit. This request, sometimes referred to as an ‘expression of wish’ or ‘death benefit nomination’, is not legally binding on the scheme administrator or trustees. 

Although an expression of wish is not binding, if a member has submitted one, it should be reviewed from time to time to take into account any changes in personal circumstances (for example, marriage or divorce, the birth of another child or the death of an existing nominee).

It’s worth noting that pension contracts in the member’s own name – e.g. section 32 (buyout) policies, section 226 retirement annuity contracts and policies assigned from occupational pension schemes – generally pay any lump sum death benefit directly to the member’s estate. As a result, the death benefit would be considered for IHT. This can be avoided if the contract is placed in trust.

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. They allow the trustees (which could include 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 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.

IHT is due when, on an individual’s death, the estate is worth more than the current ‘nil rate band’ – for the 2016/17 tax year this is £325,000. The nil rate band may be higher than this – if someone dies and their nil rate band is not fully utilised, the unused amount can be transferred to their spouse or civil partner. The IHT rate is currently 40% of the value of the estate above the nil rate band. 

Lump sum death benefits paid from occupational or personal pension schemes are generally not considered for IHT because they are paid at the discretion of a third party (usually the scheme administrator/trustees).

Any benefit paid to a surviving spouse, civil partner or financial dependant will not be considered for IHT in any circumstance. Any benefit paid to the member’s estate following a discretionary decision made by the scheme administrators or trustees would not be considered for IHT either.

HMRC may consider IHT where:

  • contributions are made to pension schemes by the member or their employer in the two year period prior to the member’s death, whilst they were in ill-health. HMRC will only look at cases where an established pattern of contributions has been altered with the aim of enhancing the death benefit possibly passing to beneficiaries.
  • there is a transfer of pension benefits in the two year period prior to the death of the member whilst in ill-health, either by transferring from one scheme to another or transferring the death benefits into a trust.
  • the member is able to give the trustees or scheme administrator a written direction to make a payment to a certain person and has complete freedom in who they choose (this is a binding nomination and is not the same as an expression of wishes).
  • pension payments within a guaranteed term continue to be paid to the estate as of right after the member’s death  
  • the payment of a lump sum death benefit is not made at the discretion of any trustees and payment is made to the estate.

Where a member has no dependants, a charity lump sum death benefit may be payable if the scheme rules allow. Generally, a charity lump sum death benefit can be paid:

  • From the member’s remaining drawdown or flexi-access drawdown pension funds.
  • From the member’s remaining uncrystallised fund under a money purchase arrangement:
    • Where the payment was made before 16 September 2016, the member must have reached age 75 before death in order for the lump sum to be a charity lump sum death benefit
    • From 16 September 2016, there is no age restriction
  • From a dependant’s drawdown or dependant’s flexi-access drawdown pension fund where the dependant dies and there are no other dependants of the member
  • From a nominee’s or successor’s flexi-access drawdown pension fund where the nominee/successor dies and there are no other dependants on the member

The member, dependant, nominee or successor must nominate the charity – the scheme administrator can’t select the charity if no nomination is made before the member, or beneficiary, dies.

 A charity lump sum death benefit can only be paid where there are no dependants of the member. For this purpose, a child dependant is:

  • Children under the age of 23, or
  • Children who are dependants because of physical or mental impairment (the age 23 limit does not apply here).

The extended meaning of child dependant introduced on 16 September 2016 for continuing dependant’s drawdown for children who are dependant and reach age 23 does not apply here (See ‘Who can be a dependant, nominee or successor?’ for more information on this).

Payment of a charity lump sum death benefit is tax free so long as it’s used for charitable purposes.

A charity lump sum death benefit is not a BCE and doesn’t trigger a lifetime allowance test. 

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