Adviser > Technical Central > Information & guidance > Death benefits > Death benefits
Death benefits
Key points
- There are a number of factors which affect death benefit provision on the member’s death. These include
- Whether or not the member was in receipt of their benefits when they died
- The type of pension the member was in receipt of (if applicable)
- The age of the member at date of death.
-
The HMRC have a definition of the word 'dependant' and an individual must meet this in order to be paid a dependants pension- Inheritance tax is not usually payable on lump sum death benefits but there are some circumstances where there could be a liability.
Death benefit provision within pension schemes can be complex. This analysis focuses on death benefits both before and after retirement and the range of options available under each situation. What options are actually available will of course depend on the rules of the relevant pension scheme.
Options...at a glance
The tables below give an overview of the various options available to the beneficiary. Please click on the option for further details
Options available if the member dies before taking their benefits:
| Type of benefit required by dependant | Options available to dependant |
|---|---|
| Lump sum/return of fund | - |
| Secured pension |
|
| Drawdown pension |
|
Options available if the member dies after taking their benefits:
| Type of pension taken by member | Options available to dependant |
|---|---|
| Secured Pension |
|
| Capped drawdown |
|
Death before taking benefits
Lump sum/return of fund
Whilst there is, in theory, no limit on the amount of lump sum death benefit that can be provided under a registered pension scheme, the rules will still determine what can actually be paid out in terms of death benefits. For example scheme rules could allow four times salary as a lump sum death benefit or simply a return of fund. But it's important to note that a tax charge will apply to any lump sum death benefit payable at date of death in excess of :
- the standard lifetime allowance (SLA), or
- the personal lifetime allowance (PLA) if primary protection (PP) has been chosen, or
- the 'benefits value' (e.g. fund value) if enhanced protection (EP) has been chosen.
This tax charge, which is known as the ‘lifetime allowance charge’, will be applied to any excess lump sum death benefit over the SLA/PLA/benefits value at a rate of 55%, payable by the recipient of the lump sum.
Any fund remaining in excess of SLA can be used to provide dependants' pensions without having to pay the charge. Protected Rights funds must be used to provide a dependant's pension for any surviving spouse.
If the member was 75 or over at date of death, the whole lump sum will be subject to a 55% tax charge.
Dependants’ pensions
Dependants’ pensions are not tested against the deceased’s or recipient's SLA or PLA, and can be paid on top of any lump sum death benefit. This means that the value of any benefits above the deceased's SLA or PLA can be used to provide dependants' pensions. If all excess benefits are used in this way the lifetime allowance charge can be avoided.
In order to be paid a dependant's pension for life, individuals still need to qualify as 'dependants’. This includes:
- legally married spouse,
- unmarried partner (a ‘common-law’ husband or wife or someone of the same sex) can be treated as a dependant, where the relationship was one of financial dependence on the member or financial interdependence,
- children – under the age of 23 or older in the case of dependency due to mental or physical incapacity,
- ex-spouse if they were married to the member when they first started to take the pension,
- and any other person that the scheme administrator considers dependent on the deceased at the time of death due to physical or mental impairment, or financial dependency or that there was financial interdependence between that person and the member.
Dependants’ benefits can be paid in one or a combination of two ways:
- secured pension and/or
- drawdown pension.
Income can be secured in two ways. Either by:
- buying a scheme pension, or
- buying a lifetime annuity.
Defined benefit schemes can only offer a scheme pension. Also, money purchase schemes have to offer open market options if income is to be secured by an annuity.
Scheme pension
A scheme pension may be provided under both a defined benefit or a money purchase scheme. To be a scheme pension the pension:
- must be paid for the life of the dependant,
- must be paid at least annually,
- must not be capable of being reduced year on year,
- must be paid by the scheme administrator or by an insurance company chosen by the scheme administrator,
- and may be guaranteed for a set period of no more than ten years.
Lifetime annuity
Only a money purchase scheme can provide a lifetime annuity. To meet the lifetime annuity definition the annuity contract must:
- be purchased from an insurance company of the dependant's choice
- be payable for life
- be paid at least once a year, either in advance or in arrears
- stay level or increase
- not allow the payment of a capital sum triggered by the dependant’s death, apart from annuity protection
- not be capable of being assigned or surrendered, unless there is a pension sharing order.
Again, income can be paid in two ways. Either by:
- income drawdown, or
- short-term annuities.
Income drawdown (ID)
The minimum income under income drawdown (ID) is 0% and the maximum income is 100% of the relevant Government Actuary's Department (GAD) single life annuity rate based on gender with no guarantee. Any level of income can be selected between these limits but this must be reassessed every 3 years. The Finance Act 2007 introduced the facility for members to request a review at the end of each unsecured pension year. The scheme administrator can grant or refuse this request at their discretion.
If income drawdown was entered into before 6 April 2011, the maximum income is based on 120% of GAD until the next review date. See Changes to GAD reviews.
Short-term annuities
Short-term annuities allow a dependant to purchase an annuity, or a series of annuities (on the open market, if required), with all or part of their fund. The annuity term cannot be more than 5 years.
Should the dependant die under ID any remaining fund not used to provide income can be paid as a lump sum subject to a 55% tax charge.
Death after taking benefits
The death benefit situation after benefits have been crystallised depends on the way in which benefits were crystallised.
Secured pension
Where secured pension was used to crystallise benefits the options available to a deceased’s dependants are as follows:
- if the annuity was purchased with an attaching dependants pension this would be payable for the remainder of the dependant's life, or
- if the annuity was purchased with a guarantee period (maximum 10 years) pension instalments will continue until the end of any guaranteed period.
- pension protection - a lump sum death benefit payment based on the difference between the annuity purchase price when secured pension was selected and the income payments made to date of death taxed at 55%, or
Drawdown pension
Where drawdown pension was used to crystallise benefits the options available to the deceased’s dependants are as follows:
- continue income drawdown, or
- buy short term annuities, or
- buy a lifetime annuity, or
- any remaining fund not used to provide income can be paid as a lump sum subject to a 55% tax charge.
The income drawdown option could be useful for those clients that want to provide a range of options for their spouse.
A couple of points worth bearing in mind...
If there are no dependants a payment can be made to a registered charity.
Remember once a decision to take benefits has been made it is irreversible and clients cannot change their mind later on.
What about Inheritance tax?
On death before crystallisation
Unless lump sum death benefits are paid to the deceased member’s estate, there is not normally any liability to inheritance tax so long as the trustees decide who the lump sum should be paid to. There is a situation where there could be a liability:
- any Protected Rights funds paid out as a lump sum (only possible if there is no surviving spouse) must be paid at the member's direction or to their estate and so will be liable to inheritance tax.
On death after crystallisation or after age 75
There will be a tax charge of 55% on any lump sum death benefits paid.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.
In addition, the information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice.
Published 7 October 2004
Updated 27 January 2012
For professional advisers only
