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HMRC internal manual

Pensions Tax Manual

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Death benefits: types of pension: beneficiary's annuity

Glossary PTM000001
   

 

A beneficiary’s annuity - general
Conditions for an annuity contract to be a dependants’ or nominees’ annuity
Conditions for an annuity to be a successors’ annuity
A beneficiary’s annuity and the lifetime allowance
Taxation of a beneficiary’s annuity
Transfer of a beneficiary’s annuity from one insurance company to another
Death benefits paid from an annuity contract purchased before 6 April 2006

A beneficiary’s annuity - general

Section 167(1) Finance Act 2004 - pension rules 3, 3A and 3B

Paragraphs 17, 27AA and 27FA Schedule 28 and paragraph 3(4A) Schedule 29 Finance Act 2004

From 6 April 2015, following a member’s death, the provision of a death benefit through an annuity is no longer unauthorised if paid other than to a dependant of the deceased member.  A member’s nominee can also receive them in certain circumstances, and following the death of a dependant or nominee, a further successor can benefit – and so can further successors of successors as long as unused funds still remain.

A beneficiary’s (a dependants’ or nominees’ or successors’) annuity contract is only authorised if purchased from an insurance company by a money purchase arrangement.  This may happen for example:

  • during a member’s lifetime, where a (future) dependants’ or nominees’ annuity is purchased from funds in a money purchase arrangement alongside a lifetime annuity payable to the member.
  • following the death of the member, where a dependants’ or nominees’ annuity contract is purchased from any uncrystallised funds or drawdown fund remaining on the death of the member.  It may also be purchased from a dependant’s or nominee’s drawdown fund.
  • following the death of a dependant or nominee or successor who leaves unused funds in a drawdown fund.  A successors’ annuity can be purchased from such funds.

 

Additionally, a beneficiary’s short-term annuity ending within 5 years, can be purchased from a beneficiary’s flexi-access drawdown pension or a dependant’s drawdown pension.  Find more details on short term annuities at PTM072420.

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Conditions for an annuity contract to be a dependants’ or nominees’ annuity

Paragraphs 15(2A) and (2B), 17 and 27AA Schedule 28 Finance Act 2004

From 6 April 2015 onwards, to be a dependants’ or nominees’ annuity, the annuity contract must either:

  1. be purchased from any uncrystallised funds or drawdown fund remaining on the death of the member.  It may also be purchased from the drawdown fund of the dependant concerned, or from the flexi-access drawdown of the nominee concerned, or
  2. be a future dependants’ or nominees’ annuity provided for at the time the member purchased their own lifetime annuity.  Such an annuity can be purchased:
  • as part of the contract providing the member’s lifetime annuity, with the annuity contract being written on a ‘joint life’ basis, or
  • under a separate contract to the member’s lifetime annuity contract (whether with the same insurance company or not) so long as the separate contract was purchased within the seven days before or after the purchase of that lifetime annuity.

A dependants’ or nominees’ annuity purchased under 2. above is referred to in the legislation as a ‘related annuity’.

An annuity providing for a future pension benefit to a dependant or nominee of a member that is purchased in the member’s lifetime but outside the timeframe at 2. above is not a dependants’ or nominees’ annuity.

 

Additionally:

  • the dependant or nominee must become entitled to their annuity on or after 6 April 2015
  • in the case of a nominee’s annuity, the member’s death must be on or after 3 December 2014, with the nominee becoming entitled to their annuity on or after 6 April 2015
  • the annuity must be payable by an insurance company.  For the avoidance of doubt, the condition that required the member or dependant (as appropriate) to have the opportunity to select the insurance company paying the annuity does not apply from 6 April 2015
  • the annuity must be payable until the dependant’s or nominee’s death unless the contract provides for the annuity to end on earlier marrying or entry into a civil partnership – however, if they are a dependant who is a child of the member, the annuity must be payable until the earliest of the dependant ceasing to be a dependant or dying, unless the contract provides for the annuity to end on earlier marrying or entering into a civil partnership.

The extended meaning of dependant for a child of the member who reached age 23 on or after 16 September 2016 does not apply in respect of dependants’ annuities. So, if the child is not a dependant because of physical or mental impairment, the annuity must cease by age 23.

Dependants’ annuity before 6 April 2015

Before 6 April 2015, the tax rules did not allow for a nominees’ annuity and different conditions applied for a dependants’ annuity.  To be a dependant’s annuity contract, an annuity contract had to:

  • be purchased either with the member’s lifetime annuity (so it is a related dependants’ annuity) or after the member’s death and the member or dependant (as appropriate) became entitled to their annuity before 6 April 2015 (as described in the above paragraphs)
  • be payable by an insurance company, with the member or dependant (as appropriate) having had the opportunity to select the insurance company (see the section ‘The open market option - annuities purchased before 6 April 2015’ below)
  • be payable until the dependant’s death unless the contract provides for the annuity to end on earlier marrying or entering into a civil partnership - however if the dependant is a child of the member, the annuity must be payable until the earliest of the dependant ceasing to be a dependant or dying, unless the contract provides for the annuity to end on earlier marrying or entering into a civil partnership
  • not provide for the direct or indirect payment of capital or pension payments triggered by the death of the dependant, so payment of the annuity could not be guaranteed for a term certain
  • be paid at least once a year, whether in advance or in arrears, and
  • provide for an amount of annuity to be paid each year which could not decrease or could only do so in circumstances prescribed by HMRC regulations.

 

For annuity contracts where the entitlement to the annuity arose before 6 April 2015, the circumstances in which the annual rate of income provided by a dependants’ annuity contract may be varied are essentially the same as the circumstances where the income provided by a member’s lifetime annuity may be varied - see PTM062400 (substituting any reference to ‘member’ with ‘dependant’, except where specifically mentioned in the text). These circumstances include the application of a pension sharing order that reduces the income provided by a dependants’ annuity.

 

The open market option - annuities purchased before 6 April 2015

Paragraph 17(1)(b) Schedule 28 Finance Act 2004

The member or dependant must have been given the opportunity to choose the insurance company the dependants’ annuity is purchased or provided from. This is often called an open market option.

Where the dependants’ annuity is secured with the member’s lifetime annuity the choice will be one for the member to make at the time of purchase. Where the annuity is being secured after the death of the member, the choice is that of the dependant.

If the member or dependant is not given the opportunity to choose their annuity provider, the resulting annuity contract does not satisfy the conditions to be a dependants’ annuity, as the legislation specifically requires that the member or dependant must have the opportunity to choose the contract provider.

If the member or dependant has the opportunity but fails to select an insurance company to provide the dependants’ annuity, the scheme administrator or scheme trustees may select the insurance company.

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Conditions for an annuity contract to be a successors’ annuity

Section 167(1) Finance Act 2004

Paragraph 27FA Schedule 28 Finance Act 2004

To be a successors’ annuity, the annuity contract must:

  • be purchased using undrawn funds which were held for a beneficiary’s flexi-access drawdown fund immediately before their death, or funds derived/arising from that flexi-access drawdown fund
  • be purchased after the beneficiary’s death, which occurred on or after 3 December 2014, with the successor becoming entitled to their annuity on or after 6 April 2015
  • be payable by an insurance company, and
  • be payable until the successor’s death or (optionally) earlier marrying or entry into a civil partnership.

 

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A beneficiary’s annuity and the lifetime allowance

Where the dependants’ or nominees’ annuity is a related annuity (see Conditions for an annuity to be a dependants’ or nominees’ annuity), the amount crystallising is a BCE 4 (see PTM088640) of the aggregate purchase price of the member’s lifetime annuity and the related dependants’ or nominees’ annuity.

From 6 April 2015, any relevant unused uncrystallised funds used to purchase a dependants’ or nominees’ annuity are tested against the member’s lifetime allowance as a BCE 5D (see PTM088660) if:

  • the member died on or after 3 December 2014
  • the member was under the age of 75 when they died, and
  • the dependant’s or nominee’s entitlement to the annuity arose within the relevant two year period.

 

Otherwise, where the entitlement to a dependants’ or nominees’ annuity arises on or after the death of the member, the purchase is not a benefit crystallisation event (BCE) and so does not give rise to a lifetime allowance charge.  This is because the funds either will have already been tested against the lifetime allowance when crystallised by the member, or they will be subject to a tax charge on the beneficiary.

As a successors’ annuity can only be purchased from funds which have already crystallised, the purchase is not a BCE.

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Taxation of a beneficiary’s annuity

Sections 579A to 579D, 646B, 646C and 683 Income Tax (Earnings and Pensions) Act 2003

Payments of a dependants’ or nominees’ annuity, in respect of a deceased member, are free of tax in the hands of the recipient dependant or nominee where the annuity is purchased:

  • using the member’s unused drawdown funds
  • using the member’s unused uncrystallised funds
  • as a ‘related annuity’ together with a lifetime annuity payable to the member
  • from sums transferred from one insurance company to another on cessation of a prior dependants’ or nominees’ annuity, which was purchased using the member’s unused drawdown funds or unused uncrystallised funds, or as a ‘related annuity’ together with a lifetime annuity payable to the member, or
  • using the person’s own drawdown fund (including dependant’s drawdown pension fund, dependant’s flexi-access drawdown fund and nominee’s flexi-access drawdown fund)

and

  • the member died on or after 3 December 2014
  • the member died before reaching age 75, and
  • no payment of the dependants’ or nominees’ annuity was made before 6 April 2015 (if there has been a transfer, this includes the prior annuity and any others in the chain)

and

  • if the funds used to purchase the annuity were at least partly from the member’s unused uncrystallised funds, the entitlement to the annuity (the prior annuity if there has been a transfer) arose within the relevant two year period (beginning with the earlier of the day the scheme administrator first knew of the member’s death, or could first reasonably have been expected to know of it), [this does not apply to related annuities]

 

  • if the person designated the member’s unused uncrystallised drawdown funds as available for dependant’s or nominee’s drawdown, from which the dependants’ or nominees’ annuity is purchased, that designation was within the relevant two year period (as above), and

 

  • in the case of an annuity purchased from the person’s own dependant’s drawdown pension fund or from their dependant’s flexi-access drawdown fund which became a newly-designated dependant fund (either by conversion from a capped drawdown fund since 5 April 2015 or on automatic conversion from a flexible drawdown fund on 6 April 2015):
    • there has been no payment of income withdrawal from the fund (or any fund represented by it) before 6 April 2015, and
    • there have been no payments before 6 April 2015 from any other annuities purchased from the fund.

 

 

A successors’ annuity can be paid free of tax in the hands of the successor where the annuity is purchased:

  • using a deceased beneficiary’s undrawn funds
  • from sums transferred from one insurance company to another on cessation of a prior successors’ annuity, which was purchased using undrawn funds, or
  • using the person’s own successor’s flexi-access drawdown fund

and

  • it is paid in respect of a deceased member of a registered pension scheme
  • it is paid on the subsequent death of a beneficiary (a dependant, nominee or preceding successor of the member) who died on or after 3 December 2014
  • the beneficiary died before reaching age 75, and
  • no payment of the successors’ annuity was made before 6 April 2015 (if there has been a transfer, this includes the prior annuity and any others in the chain).

 

 

Otherwise, payments of a beneficiary’s annuity are taxed on the recipient as pension income through PAYE.

See the further rules for Death benefits paid from an annuity contract purchased before 6 April 2006

 

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Transfer of a beneficiary’s annuity from one insurance company to another

Paragraph 17(3)to(5), 27AA(3)to(5) and 27FA(3)to(5) Schedule 28 Finance Act 2004

The Registered Pension Schemes (Transfer of Sums and Assets) Regulations 2006 - SI 2006/499

A beneficiary’s annuity contract represents the contractual liability of an insurance company to pay a pension to a beneficiary in respect of a member of a registered pension scheme, either for life or until a given situation arises.

The onward transfer of that liability to another insurance company is not a recognised transfer under section 169 Finance Act 2004 because the sums and assets transferred do not specifically represent the rights of the beneficiary.

However, the above mentioned regulations permit an insurance company to transfer to another insurance company sums and assets relating to their liability under a beneficiary’s annuity contract, providing certain conditions are met. The relevant regulations set out how the transferred funds must be treated by the insurance company receiving them. Where they are used to provide a new beneficiary’s annuity, the new annuity is treated as if it were the original beneficiary’s annuity. They can also prescribe that any payment made by an insurance company where those prescribed conditions are not met may be treated as an unauthorised member payment made by the registered pension scheme that purchased the original beneficiary’s annuity contract.

Essentially, the intention behind the Regulations is that the receiving insurance company should continue to provide the beneficiary with a beneficiary’s annuity on the same terms as previously.

There is no obligation requiring an insurance company to either make or accept a transfer of a beneficiary’s annuity liability. It is not something the beneficiary can instigate without the agreement of the insurance company concerned. There would of course also need to be agreement between the two insurance companies on the value of the annuity business in question based on an analysis of the policy terms and conditions.

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Death benefits paid from an annuity contract purchased before 6 April 2006

Section 161(3A) and paragraph 45A Schedule 36 Finance Act 2004

Sections 612 and 683 Income Tax (Earnings and Pensions) Act 2003

Article 2 The Taxation of Pension Schemes (Transitional Provisions) Order 2006 - SI 2006/572

An annuity contract purchased before 6 April 2006 (from any tax-approved scheme) and in payment at that date is not a registered pension scheme, and so is not within the lifetime annuity or dependants’ or nominees’ annuity definition.

Any pension death benefit provided by such a contract will reflect the dependency tax rules applying before 6 April 2006 to the scheme under which the benefit is provided. As a result, the contract terms may provide for payment of an annuity to a child dependant that continues beyond age 23 where that individual is still in full-time education or vocational training or for the annuity payments to stop earlier.

Article 2 of the above Order modifies section 161 Finance Act 2004 by extending the scope of section 161(3) to cover payments made or benefits provided from annuity contracts purchased by approved schemes before 6 April 2006. However, paragraph 3 of the Article excludes certain annuities purchased from insurance companies from this extension, provided:

  • the terms of the annuity contract, or any arrangement or agreement made in connection with that annuity do not permit a payment, the making of which would have given the Board grounds for withdrawing tax approval of the pension scheme under Section 591B ICTA 1988, if it had been made before 6 April 2006, and
  • the terms of the annuity contract have not been altered on or after 6 April 2006 to allow a payment that would be an unauthorised payment if it had been made by a registered pension scheme.

 

Paragraphs 4 and 5 of the Article deal with approved schemes which were wound up prior to 6 April 2006. The wording of section 161(4) is modified in respect of these schemes so that the payment is deemed to be made by a registered pension scheme.

Taxation

A dependant’s annuity that was purchased together with a member’s life annuity before 6 April 2006 can be paid tax free where:

  • it is paid in respect of the deceased member after their death
  • the member died on or after 3 December 2014
  • the member died before reaching age 75
  • no payment of the dependants’ annuity was made before 6 April 2015
  • the dependants’ annuity fulfilled the transitional conditions of article 2(3) of The Taxation of Pension Schemes (Transitional Provisions) Order 2006 – SI 2006/572 at all times on and after 6 April 2006, and
  • the annuity payable to the member also fulfilled the transitional conditions at all times between 6 April 2006 and the member’s death.

 

Such an annuity could have been purchased:

  • as part of the contract providing the member’s lifetime annuity, with the annuity contract being written on a ‘joint life’ basis, or
  • under a separate contract to the member’s lifetime annuity contract (whether with the same insurance company or not) so long as the separate contract was purchased within the seven days before or after the purchase of that lifetime annuity.

 

Otherwise, the dependants’ annuity is taxable as pension income on the recipient through PAYE.

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