Defined contribution pension schemes are particularly flexible when it comes to the payment of death benefits.
The full value of the remaining pension pot is available and a range of death benefits can be selected.
The availability of beneficiary drawdown also has potential inheritance tax advantages.
We will look at the options available and consider the impact of the new lifetime pension limits.
Lump sums or income?
DC death benefits fall into one of two main categories: lump sums or income.
The full range that is available depends on the scheme.
Pension legislation allows for the payment of a variety of lump sums, but to the recipient they amount to the same thing, which is a sum of money paid direct to them and, therefore, within their estate.
Using death benefits to purchase an income product usually means purchasing an annuity – a scheme pension is rare in the DC environment – or designating funds to beneficiary drawdown.
Where funds are left to a charity or a separate trust, a lump sum must be paid.
In many cases, the beneficiary can select from the range of death benefits available following discussion with the pension scheme trustees and could have part paid as a lump sum and part paid as an income.
Again, beneficiary drawdown is highly flexible in this regard as it is allows for the payment of a regular income as well as full access to the fund, so where it is available there is little point in splitting the death benefits.
Lump sum death benefits
The payment of a lump sum is a common form of death benefit from DC pensions and can be paid from crystallised or uncrystallised funds.
In some cases, certain beneficiaries will not be eligible for beneficiary drawdown, or the scheme does not offer it, so if a beneficiary does not want death benefits paid in the form of an annuity a lump sum may be their only option.
The full range of lump sum is detailed in the pension tax manual (PTM073000) on the HMRC website. It is important to know exactly which lump sum is being paid as the conditions and tax treatment can differ.
More generally, the tax position of lump sum death benefits is largely the same as it was before the lifetime allowance was abolished.
As before April 6 2024, the tax treatment depends on whether the member died before or after age 75.
Pre-75
Lump sum death benefits paid to a beneficiary following the member’s death before age 75 are tax-free up to the available lump sum and death benefit allowance (LSDBA) if they are paid within two years of the member’s death or within two years of the earliest date the scheme could reasonably have been expected to learn of the member’s death.
If there is an excess above the LSDBA it is subject to the beneficiary’s marginal rate of income tax.
