PTM071000 - Death benefits: essential principles: overview

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Authorised benefits payable on death
Types of arrangement providing death benefits
Overview of the authorised pension death benefits
Overview of authorised lump sum death benefits
Taxation of death benefits

Authorised benefits payable on death

Sections 167 and 168 and Schedules 28 and 29 Finance Act 2004

Registered pension schemes may pay lump sum or pension benefits following the death of a member or a beneficiary.

It is up to the pension schemes trustees or scheme manager to decide who will receive what benefits and how much. Schemes can pay more than one type of benefit. If there is more than one person who is eligible to receive benefits, schemes can choose to pay as many or as few beneficiaries as they wish. Schemes can choose to pay more than one type of benefit to the same person, for example a lump sum death benefit and pension death benefit.

Normally members are asked to nominate who they wish to receive a benefit following their death. Generally, the scheme trustees or provider are not required to follow the member’s wishes. Benefits will be paid at the discretion of the scheme trustees or manager, but they will consider the member’s wishes when deciding who to make payment to and how much.

The pension scheme rules should set out who may be paid benefits and the considerations for trustees and scheme managers when deciding what benefits to pay.

However, note that section 273B Finance Act 2004 gives scheme trustees and managers the ability to pay certain authorised money purchase pensions and lump sums that wouldn’t otherwise be allowable under the scheme rules.

When a member purchases a lifetime annuity, they can choose what death benefits may be provided, and to whom, under the terms of the annuity contract.

Lump sums and pension paid following the death of a member or beneficiary are ‘payments in respect of a member’ and so need to be considered against the authorised payments framework. The tax legislation sets out:

  • all the authorised forms of pension and lump sum death benefits,
  • the circumstances in which those benefits can be paid, and
  • the conditions and restrictions that the payments of the benefits must meet or follow in order for them to be ‘authorised’.

Authorised death benefits fall into two categories – pension death benefits and lump sum death benefits.

Section 167 sets the ‘pension death benefit rules’ specifying which arrangements can pay which type of authorised pension benefits following the death of a member or beneficiary. Part 2 Schedule 28 supplements this section specifying the payment conditions for each type of authorised pension death benefit.

Section 168 sets the ‘lump sum death benefit rules’ listing the types of payments that are authorised lump sum death benefits. Part 2 Schedule 29 supplements this section specifying the payment conditions for each type of authorised lump sum death benefit.

The types of authorised benefits a registered pension scheme can class as authorised payments following the death depends on:

  • the type of pension arrangement providing the benefit – see Types of arrangement providing death benefits below,
  • whether or not the member crystallised benefits (put benefits into payment), and
  • where benefits were crystallised, the type of pension that was provided to the member.

A member may have had a mixture of crystallised and uncrystallised rights under a pension scheme when they died. They may also be receiving different types of pension from the pension scheme.

PTM071100 provides guidance on the types of authorised death benefits payable following the death of a member.

PTM071400 provides guidance on the authorised death benefits payable following the death of a beneficiary.

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Types of arrangement providing death benefits

The types of authorised benefits a registered pension scheme can pay depends on the type of arrangement providing the benefit.

It is the form of the death benefits promised under the terms of the pension scheme that sets the type of arrangement.

Pension schemes can use insurance policies (term life/life cover policies) to fund the promised death benefits. The arrangement type depends on the pension promise, not the wording of the policy that is used as the mechanism to deliver the promise.

The type of arrangement providing death benefits may be different to the type of arrangement providing pension benefits to the member. For example, a member’s pension may be promised on an other money purchase basis but the promised death benefit may be a defined benefit.

Money purchase: Other money purchase arrangements

The amount of benefits provided is wholly dependent on the amount of payments made to the arrangement by or in respect of the member. An example of benefits provided from an other money purchase arrangement is a return of the member’s fund.

Money purchase: Cash balance arrangements

The amount of benefits provided is dependent on the amount that has been promised will be made available to provide those benefits. The amount available to provide benefits is not dependent on the payments that have been made by or in respect of the member of the arrangement.

For example a member is promised that £3 million worth of death benefits will be provided.

Defined benefits arrangements

The amount of benefits provided is not dependent on the amount that will be made available to provide benefits. Examples of benefits from such an arrangement are:

  • a lump sum death benefit of 4 x salary,
  • a lump sum of a fixed amount of benefit e.g. £100,000 even if provided by a life cover policy, or
  • a dependant’s pension of a fixed amount, e.g. £50,000 pa or 2/3rds of the member’s pension.

However, a fixed amount e.g. £100,000 that is to paid out on death but which has not been expressed in benefit terms, so might be paid in the form of either a pension or a lump sum, is not a defined benefit but a cash balance benefit. This is because the form of the benefit will not be decided on until on or after the death so there is no defined benefit.

More than one type of arrangement

The promised benefit following the death of a member may be provided using more than one type of arrangement. For example, if the benefit promise is a return of the member’s fund and a lump sum of £50,000, the return of the fund would be provided under an other money purchase arrangement and the £50,000 lump sum under a defined benefits arrangement.

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Overview of the authorised pension death benefits

Section 167 and paragraph 15 Schedule 28 Finance Act 2004

Authorised pension death benefits can be paid to a dependant, nominee, or successor; collectively known as beneficiaries.

PTM071100 explains what authorised benefits may be paid following the death of a member. Authorised pension death benefits following the death of a member are payable to a dependant or nominee only. See PTM071200 for more information about the meaning of the term ‘dependant’ and PTM071300 for guidance on the meaning of the term ‘nominee’.

PTM071400 explains which authorised benefits may be paid following the death of a beneficiary. Only money purchase arrangements may provide authorised benefits following the death of a beneficiary. An authorised pension paid following the death of a beneficiary is payable to a successor of the member only. PTM071300 provides guidance on the meaning of the term ‘successor’.

The types of authorised pension death benefit from 6 April 2015 are as follows:

  • A dependant’s scheme pension. This pension death benefit is payable to a dependant from both a defined benefits arrangement and a money purchase arrangement - see PTM072100.
  • A beneficiary’s annuity. This This is an annuity purchased from an insurance company that is payable to a dependant, nominee or successor. It is payable in respect of a money purchase arrangement only - see PTM072200.
  • A beneficiary’s drawdown pension. This pension death benefit is payable from a money purchase arrangement only. The beneficiary must designate sums or assets to provide drawdown pension which creates a flexi-access drawdown fund. The drawdown pension can be paid directly from the beneficiary’s flexi-access drawdown fund as beneficiary’s income withdrawal. Alternatively, funds from the beneficiary’s flexi-access drawdown fund may be used to purchase a beneficiary’s short-term annuity. A combination of income withdrawal and short-term annuity can be paid - see PTM072400.

Before 6 April 2015 the authorised pension death benefits were payable only to a dependant and were as follows:

  • A dependant’s scheme pension – see PTM072100. There were no changes made to the rules relating to dependant’s scheme pension from 6 April 2015.
  • A dependants’ annuity. This is an annuity purchased from an insurance company using funds from a money purchase arrangement. See PTM072200 for guidance on the payment conditions for a dependants’ annuity purchased before 6 April 2015.
  • A dependant’s drawdown pension – see PTM072300. The dependant designated sums or assets held under a money purchase arrangement to provide them a drawdown pension. This created a dependants’ drawdown pension fund. Just like beneficiary’s drawdown pension, a dependants’ drawdown pension may be paid as income withdrawal and/or short-term annuity. Before 6 April 2015 dependants’ drawdown pension came in two forms – flexible drawdown and capped drawdown. With flexible drawdown there was no limit on the amount that could be paid as out each year. With capped drawdown there was a limit of the amount of drawdown pension that could be paid each year.

Dependants’ flexible drawdown converted to dependant’s flexi-access drawdown on 6 April 2015 – see PTM072440. Dependants’ capped drawdown may continue under the rules in place before 6 April 2015. Alternatively, a dependant can choose to convert to flexi- access drawdown – see PTM072450.

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Overview of authorised lump sum death benefits

Section 168 and Part 2 Schedule 29 Finance Act 2004

Each of the authorised lump sum payments has a different set of prescribed characteristics. Some are paid tax-free (subject to available lifetime allowance), and some are subject to specific tax charges.

The circumstances and conditions defining these payments are set out in the legislation. The type of lump sum death benefit payment that can be made under an arrangement varies depending on the exact circumstances and the type of arrangement involved.

PTM071100 provides guidance on the authorised death benefits payable following the death of a member.

PTM071400 provides guidance on the authorised death benefits payable following the death of dependant, nominee or successor.

There is no restriction under the tax rules on who may be paid an authorised lump sum death benefit. The exceptions to this rule are:

  • charity lump sum death benefit,
  • trivial commutation lump sum death benefit.

Lump sums do not have to be paid to an individual; they may be paid to a trust, charity or company, or the deceased member’s estate. Schemes can pay a lump sum death benefit to more than one person.

The authorised lump sum death benefits are:

  • Defined benefits lump sum death benefit: a lump sum paid from a defined benefits arrangement following the death of a member. See PTM073100 for detailed guidance on the payment conditions and tax treatment of this lump sum.
  • Pension protection lump sum death benefit: a lump sum paid in certain circumstances following the death of a member whose scheme pension was in payment when they died. It is payable from a defined benefits arrangement only - see PTM073300.
  • Uncrystallised funds lump sum death benefit: a lump sum paid following a member’s death from any remaining uncrystallised money purchase funds. See PTM073200 for detailed guidance on the payment conditions and tax treatment of this lump sum.
  • Annuity protection lump sum death benefit: a lump sum paid following the death of a member who was receiving either a lifetime annuity or a scheme pension at the time of their death. It is payable from a money purchase arrangement only - see PTM073400.
  • Drawdown pension fund lump sum death benefit: a lump sum paid on the death of the scheme member or a dependant who was receiving drawdown pension when they died. For detailed guidance on the payment conditions and tax treatment of this lump sum, see PTM073500.
  • Flexi-access drawdown fund lump sum death benefit: a lump sum paid on the death of the scheme member or beneficiary who was receiving drawdown pension when they died. See PTM073600 for detailed guidance on the payment conditions and tax treatment of this lump sum.
  • Charity lump sum death benefit: a lump sum paid to a charity following the death of the scheme member or beneficiary. Such a lump sum cannot be paid whilst there is still a surviving dependant of the member, excepting some child dependants over age 23. It is payable from a money purchase arrangement only - see PTM073900.
  • Trivial commutation lump sum death benefit: if a dependants’ pension, or a continuing payment of the member’s pension under a pension guarantee, is small it may be commuted into this lump sum. It is payable from both a defined benefits arrangement and a money purchase arrangement . From 6 April 2015 the maximum amount of this lump sum is £30,000. For detailed guidance on the payment conditions and tax treatment of this lump sum - see PTM073700.
  • Winding-up lump sum death benefit: this lump sum can no longer be paid. It was a lump sum up to £18,000 which was payable before 6 April 2015. It was paid instead of their pension to a dependant because the scheme was being wound up and which extinguishes their rights under the scheme. This type of lump sum could have been paid from either a defined benefits or a money purchase arrangement. From 6 April 2015 a trivial commutation lump sum death benefit can be paid where the scheme is being wound-up. For guidance on winding-up lump sum death benefits, see PTM073800.
  • Life cover lump sum: a lump sum death benefit paid following the death of a member after they reached age 75 and whose scheme before 6 April 2006 allowed lump sums to be paid in respect of funeral expenses or funeral grants - see PTM074000.

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Taxation of death benefits

The tax treatment of any particular benefit will depend on the form of the payment. Any payment that is not an authorised payment is an unauthorised payment and will be taxed as such (see PTM131000).

The tax treatment of authorised payments varies depending on a variety of factors including:

  • the form of the payment,
  • the age the member was when they died,
  • who is receiving the payment,
  • when the benefit was put into payment, and
  • how long after the member’s death entitlement to the death benefit payment arose.

The provision of some types of death benefit following the death of a member aged under 75 is a benefit crystallisation event. Provision of these benefits uses up the member’s available lifetime allowance and the benefit recipient may be liable to pay the lifetime allowance charge.

The detailed guidance for each type of benefit sets out how it is treated for tax purposes, including the lifetime allowance.