Death benefits: types of pension: beneficiary's flexi-access drawdown from 6 April 2015: a beneficiary's short-term annuity from 6 April 2015
Paragraphs 20, 27C and 27H Schedule 28 Finance Act 2004
The Registered Pension Schemes (Transfers of Sums and Assets) Regulations 2006 - SI 2006/499
As long as the scheme rules allow it, a beneficiary may use funds that have been designated as available for the payment of dependant’s drawdown pension or beneficiary’s flexi-access drawdown to purchase a beneficiary’s short-term annuity which will provide a guaranteed income stream during the term of the annuity. With a beneficiary’s short-term annuity contract, the beneficiary annuity is paid by the insurance company rather than, as for income withdrawal, being paid directly from their dependant’s drawdown pension fund or beneficiary’s flexi-access drawdown fund.
Conditions for a beneficiary’s short-term annuity
Paragraphs 20(1) Schedule 28 Finance Act 2004
Where a beneficiary becomes entitled to a fixed-term annuity on or after 6 April 2015, it qualifies as a beneficiary’s short-term annuity for the purposes of the tax rules if it is:
- purchased by the application of sums or assets representing all or part of a dependant’s drawdown pension fund or a beneficiary’s flexi-access drawdown fund,
- payable by an insurance company, and
- payable for a term not exceeding 5 years and ending before the beneficiary dies.
The beneficiary becomes entitled to a beneficiary’s short-term annuity when they first acquire an actual right to receive the annuity. The tax rules do not limit the circumstances in which a beneficiary’s short-term annuity purchased on or after 6 April 2015 can be reduced. Any restriction is purely a matter for agreement between the parties to the short-term annuity contract.
Where there is a transfer of a dependant’s short-term annuity that was in payment before 6 April 2015 and so is subject to restrictions on when the annuity can decrease, special rules apply in respect of the new dependants’ short-term annuity (see PTM106000 for details).
A beneficiary’s short-term annuity contract cannot provide a benefit after the beneficiary’s death.
If the beneficiary’s short-term annuity was purchased on or after 6 April 2015, the amount can decrease from year to year. If purchased before that date, please see PTM072340.
If purchased from a flexi-access drawdown fund, there is no upper limit on the amount a beneficiary’s short-term annuity can pay. However, where a short-term annuity is bought using funds from a dependant’s capped drawdown pension fund there is an upper limit on the amount of dependant’s short-term annuity that can be paid. The amount payable from a dependant’s short-term annuity contract plus the amount of any income withdrawal from the dependant’s capped drawdown pension fund in a pension year cannot be more than the maximum drawdown pension (see PTM072300).
If the dependant is taking dependant’s capped drawdown (see PTM072300), but not otherwise, their maximum drawdown pension will be reviewed:
- at least every three years if they are under 75, and
- every year when they are 75 or older.
So, in considering the length and amount of a dependant’s short-term annuity contract the dependant may buy, they need to bear in mind that their maximum dependant’s drawdown pension could change part way through the term of the annuity. If their maximum dependant’s drawdown pension goes below the amount payable by their short-term annuity contract the excess amount will be an unauthorised payment.
Taxation of a short-term annuity
Section 167 - pension rule 3 Finance Act 2004
Sections 579A and 646C Income Tax (Earnings and Pensions) Act 2003
Payments of a dependants’ or nominees’ short-term annuity, in respect of a deceased member, are free of tax in the hands of the recipient dependant or nominee where:
- the member died on or after 3 December 2014
- the member died before reaching age 75
- the annuity was purchased out of that dependant or nominee’s drawdown pension fund or their flexi-access drawdown fund (as appropriate)
- no payment of the annuity was made before 6 April 2015
- where the funds used to purchase the annuity were the member’s unused uncrystallised funds, the entitlement to the short-term annuity 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 the day they could first reasonably have been expected to know of it),
- if the person designated the member’s unused uncrystallised drawdown funds as available for dependant’s or nominee’s drawdown pension, from which the dependants’ or nominees’ short-term annuity is purchased, that designation was within the relevant two year period (as above), and
- in the case of a short-term annuity purchased from the person’s own dependant’s drawdown pension fund or from their dependant’s flexi-access drawdown fund which became newly-designated dependant’s 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 have been no payments before 6 April 2015 from any other annuities purchased from the fund, and
- there has been no payment of income withdrawal from the fund (or any fund represented by it) before 6 April 2015.
Payments of a successors’ short-term annuity are free of tax in the hands of the successor where:
- they are paid in respect of a deceased beneficiary of a deceased member of a registered pension scheme
- the deceased beneficiary died on or after 3 December 2014
- the deceased beneficiary died before reaching age 75
- the short-term annuity was purchased from the person’s successor’s flexi-access drawdown fund.
Otherwise, beneficiary’s drawdown pension (which includes a beneficiary’s short-term annuity and beneficiary’s income withdrawal) is a form of pension for tax purposes which is chargeable to income tax as pension income. The beneficiary receiving the short-term annuity is liable for income tax on the annuity payments at their marginal rate in the tax year in which they are paid. The scheme administrator is required to deduct income tax from the annuity payments, under the PAYE regulations.