EIM75600 - The taxation of pension income: death benefits

Overview
Dependants, nominees and successors
Registered pension schemes
Foreign pensions
Annuities
Pension guarantees

Overview

Pensions or lump sums may be paid to beneficiaries following the death of an employee or a pension scheme member.

EIM75620 provides guidance on the tax treatment of lump sums paid following the death of a member of a registered pension scheme.

EIM75550 provides guidance on the tax treatment of lump sums paid from a non-UK pension scheme.

For pensions, the general rule is that the payment is taxable depending on its source. For example, a pension paid from a UK pension scheme that is not a registered pension scheme is usually chargeable to tax under section 569 ITEPA 2003 – see EIM75200 and an annuity paid under a non-registered occupational pension scheme is chargeable under section 610 ITEPA 2003 – see EIM75300.

However, some types of pension or annuity paid after 5 April 2015 to a dependant, nominee or successor may be tax-free where they are paid from either a:

  • registered pension scheme
  • foreign pension scheme that is an overseas pension scheme or a relevant non-UK scheme (RNUKS).

Some types of annuity may also be paid tax-free. The Annuities section below provides more information about this.

To work out the correct tax treatment for payments, identify:

  • the type of person receiving the pension (dependant, nominee, successor or other)
  • the type of pension scheme paying the pension or the source of the funds used to purchase the annuity (registered pension scheme, overseas pension scheme, RNUKS or other)
  • where the pension or annuity is payable under a registered pension scheme, overseas pension scheme or RNUKS, the type of pension or annuity by reference to the rules for authorised pension payments made by a registered pension scheme.

Dependants, nominees and successors

Paragraphs 15, 27A and 27F schedule 28 Finance Act 2004

Certain types of pension and annuity paid after 5 April 2015 to a dependant, nominee or successor may be tax-free. The term ‘dependant’ includes a member’s spouse, civil partner and children aged under 23. PTM071200 provides full details of who can be a dependant.

Broadly a nominee is someone who is not a dependant but who has been nominated by the member to receive benefits from the scheme following the member’s death.

A successor is someone who has been nominated by a dependant, nominee or a previous successor (the beneficiary) to receive benefits from the scheme following the beneficiary’s death.

PTM071300 provides detailed guidance on the meaning of the terms ‘nominee’ and ‘successor’.

Registered pension schemes

Sections 579A, 579CZA, 646B and 646C ITEPA 2003

Registered pension schemes may pay benefits following the death of a member or a beneficiary (a dependant, nominee or successor).

EIM75620 provides guidance on the tax treatment of lump sums paid from a registered pension scheme following the death of a member.

Any payment that is not an authorised payment is an unauthorised payment. Unauthorised payments are not taxable as pension income but separate tax charges (see PTM131000) apply.

After a member’s death a registered pension scheme may pay pensions as authorised payments to:

From 6 April 2015 a pension may be paid to a successor following the death of a beneficiary (a dependant, a nominee or another successor).

The authorised pensions payable to a dependant are:

  • dependants’ scheme pension
  • a dependants’ annuity
  • dependants’ drawdown pension.

The authorised pensions payable to a nominee or successor are:

  • a nominees’ or successors’ annuity
  • nominees’ or successors’ drawdown pension.

Any pension or annuity paid to a dependant before 6 April 2015 is taxable. It is not possible for an authorised pension or annuity to be paid to a nominee or successor before 6 April 2015.

From 2015 to 2016 a pension paid to a dependant, nominee or successor may be taxable or may be paid tax-free. This depends on the age of the member when they died and the form of the pension.

Any pension or annuity paid in respect of member or beneficiary aged 75 or older when they died is taxable.

Any annuity paid in respect of a member or beneficiary who died before 3 December 2014, at any age, is taxable.

EIM75640 provides guidance on dependants’, nominees’ and successors’ annuities and their tax treatment.

EIM75660 provides guidance on dependants’ nominees’ and successors’ drawdown pension and its tax treatment.

Taxation of dependants’ scheme pension

A dependants’ scheme pension can be paid from both money purchase and defined benefits arrangements. It may be paid either:

  • directly from the pension scheme
  • by an insurance company where an annuity contract has been purchased to secure the payment of the pension.

It is the only form of dependants’ pension that is authorised to be paid from a defined benefits arrangement. As a result, it is the type of dependants’ pension payable to a dependant from some of the largest registered pension schemes. For example, most public sector schemes will pay dependants’ scheme pensions following a member’s death. See PTM072100 for detailed guidance on the payment conditions for this type of pension.

Payments of dependants’ scheme pension are taxable as pension income of the dependant. This applies whether or not they are UK resident. The amount chargeable to tax is the amount of pension that accrues to the individual in the tax year. This may be different to the amount of pension they actually receive in the tax year.

Pension payments made whilst an individual is temporarily non-resident may become chargeable to tax on their return to the UK. EIM75450 explains when this may happen.

PAYE applies to pensions paid under registered pension schemes. The payer of the pension must apply the PAYE rules before paying the pension. The exception to this rule is pension income that becomes subject to UK tax under the temporary non-residence provisions (see EIM75450).

Foreign pensions

The tax treatment of pension paid under a non-UK pension scheme following the death of an employee or a pension scheme member depends on:

  • if the scheme is an overseas pension scheme or a relevant non-UK scheme (RNUKS)
  • the type of person receiving the payment
  • the type of pension.

Any pension or annuity payable to a UK resident from a foreign pension scheme that is neither an RNUKS nor an overseas pension scheme is chargeable to tax. EIM75500 provides further guidance on the tax treatment of these pensions.

Pension under a relevant non-UK scheme (RNUKS) or overseas pension scheme

The term ‘relevant non-UK scheme’ is set by paragraph 1(5) schedule 34 Finance Act 2004. PTM113210 provides guidance on the definition of an RNUKS, but broadly it is a foreign pension scheme that has benefitted from at least one of the following UK tax reliefs:

  • on contributions
  • funds transferred in from a registered pension scheme
  • under section 307 ITEPA 2003.

An overseas pension scheme is not simply a pension scheme set up outside the UK. The term ‘overseas pension scheme’ has a specific meaning set by section 150(7) Finance Act 2004. It is a pension scheme established outside the UK that is not a registered pension scheme, which meets certain conditions prescribed by legislation. These prescribed conditions are factual tests; being an overseas pension scheme is not a status granted by HMRC. Guidance on the conditions a scheme must satisfy to be an overseas pension scheme is in the Pensions Tax Manual at PTM112200.

If an overseas pension scheme is also an RNUKS, the RNUKS status takes priority when deciding the tax treatment of the pension.

As part of the scheme funds of an RNUKS have benefitted from UK tax reliefs some of the tax charges relating to registered pension schemes still apply to those ‘UK funds’. If a pension paid from the ‘UK funds’ would not be an authorised pension if it was paid from a registered pension scheme, it is not taxable as pension income. It is taxable as an unauthorised payment (see PTM131000). The section Registered pension schemes above outlines what pensions paid following the death of a member or beneficiary are authorised payments. The tax legislation specifies when payments are made from UK funds. See PTM113210 onwards if a pension needs to be taxed as an unauthorised payment.

If the pension or annuity is not paid from the ‘UK funds’ of an RNUKS, or it would be an authorised pension, it is taxable as follows:

  • pension or annuities paid in respect of the death of a member or beneficiary aged 75 or older when they died are taxable as pension income
  • a pension or annuity paid to a dependant, nominee or successor that is not a beneficiary’s drawdown pension or a beneficiary’s annuity is taxable as pension income
  • EIM75660 provides guidance on the tax treatment of beneficiaries’ drawdown pension
  • EIM75640 provides guidance on the tax treatment of beneficiaries’ annuity
  • A pension or annuity paid to someone other than a dependant, nominee or successor, is taxable as pension income.

Where a pension paid to a UK resident is taxable, EIM75500 provides further guidance on identifying the taxable amount of that pension or annuity.

Annuities

Sections 610 to 611A ITEPA 2003

Payments of an annuity following the death of an employee or pension scheme member where the annuity is paid under, or purchased using the funds of, an occupational pension scheme that is not a registered pension scheme, or purchased in recognition of another person’s service, are normally chargeable to tax under sections 610 or 611 ITEPA.

However, in certain circumstances if the annuity is paid in respect of the death of a member of an overseas pension scheme or relevant non-UK scheme (RNUKS) the annuity may be paid tax-free. EIM75640 provides more information about this.

Certain annuities under contract purchased before 6 April 2006 to provide benefits in respect of a member of a pre-6 April 2006 tax approved pension scheme may also be paid tax-free. See the next section to find out more.

Joint-life annuities purchased before 6 April 2006 with approved pension scheme funds

Section 611A ITEPA 2003
Paragraph 45 schedule 36 Finance Act 2004

An annuity paid to a dependant following the death of a pension scheme member on or after 3 December 2014 aged under 75 will not be taxable if all the following conditions are met:

  • it is payable under a contract purchased before 6 April 2006 using the funds of a ‘tax approved’ pension scheme which could automatically become a registered pension scheme on 6 April 2006 (see PTM031300)
  • the annuity was purchased to provide or secure benefits payable under that pension scheme
  • the annuity contract is a ‘joint-life’ annuity contract or was purchased within 7 days of the purchase of the contract providing the annuity
  • no payment was made to the dependant under the terms of the contract before 6 April 2015
  • the terms of the annuity, or any connected agreement or arrangement, do not allow for a payment that would before 6 April 2006 have given HMRC grounds to withdraw the tax approval of the pension scheme
  • the annuity contract terms have not been changed since 6 April 2006 to allow for the payment of what would be an unauthorised payment under a registered pension scheme
  • at all times on or after 6 April 2006 the annuity payable to the pension scheme member and dependant meet these conditions.

Beneficiaries’ annuity purchased from employment income

Annuities paid to a surviving spouse, civil partner or children will be taxable under section 609 where all of the following apply:

  • the annuity contract was purchased by sums paid or deducted from salary, under the terms of an individual’s employment or an Act of Parliament
  • the annuity contract was a deferred annuity contract to provide benefits following that individual’s death
  • in the year that the sum was paid or deducted from salary, the individual was UK resident or falls within section 460(3) Income Tax Act 2007.

Where the sum used to purchase the annuity was paid before 2013 to 2014 it needs to qualify for relief by meeting the conditions at either section 273 ICTA 1988 or section 459 Income Tax Act 2007. The conditions required by that legislation are largely the same as the conditions given under section 609 ITEPA 2003 (see list above) for sums paid in 2013 to 2014 or a later tax year.

Taxable amount of the annuity

Where an annuity subject to tax arises from a UK source, the person receiving or entitled to receive the annuity is liable to pay tax on the full amount of the annuity that arises in the tax year. This applies whether or not the individual is UK resident. Where the annuity is paid under, or purchased using the funds of, a non-registered occupational pension scheme, the annuity payer should operate PAYE on the annuity payments.

If the annuity subject to tax arises from a source outside the UK, it is taxable only if it is paid to a UK resident. Unless the remittance basis applies, the person receiving or entitled to receive the annuity is liable to tax on:

  • from 6 April 2017 – the full amount of the annuity arising in the tax year
  • before 6 April 2017 - 90% of the amount of the annuity arising in the tax year.

These annuities are ‘relevant foreign income’ for the purposes of chapters 2, 3 and 4 of Part 8 ITTOIA 2005. For individuals subject to the remittance basis this means tax is due when the annuity is remitted to the UK (see RDRM31030). For pre-6 April 2017 payments the 10% deduction is not available for individuals subject to the remittance basis (see RDRM10430).

Pension guarantees

Sections 579A/573 and 646B(4)/646D(4) ITEPA 2003

Some pension schemes guarantee that members will be paid a pension for a minimum period. Alternatively, when a member starts taking their pension, they can choose for their pension to be guaranteed to be paid for a certain minimum period of time. In either situation if the member dies before the end of the guarantee period, the pension can continue to be paid to one or more individuals for the remainder of the guarantee period.

There are certain limits on guarantees under a registered pension scheme - PTM071500 provides more information about this.

Payments under a pension guarantee are taxable as pension income of the recipient.

There is one exception to this rule for certain payments made on or after 6 April 2015. The pension guarantee payment is not taxable where all the following conditions are met:

  • the pension guarantee is made under a registered pension scheme, overseas pension scheme or relevant non-UK scheme (RNUKS)
  • the pension guarantee is made under a lifetime annuity contract or an annuity contract that if it had been purchased using the funds of a registered pension scheme would be a ‘lifetime annuity’ (see PTM062400)
  • if entitlement to the lifetime annuity arose before 6 April 2015 the guarantee period is not more than 10 years
  • the member died on or after 3 December 2014 aged under 75

no payments under the guarantee were made before 6 April 2015 and any payments under the contract made before 6 April 2015 were to the member only.