Death Benefits and Tax Factsheet

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Major changes to the tax charge on death benefits came into force in April 2015, the changes and new charges are explained in this factsheet.

Changes to Tax Treatment

April 2015 saw the government bring about major changes in not only the way an individual could access their pension funds but also how these funds were taxed on death.

Prior to 6th April 2015, what benefits could be paid depended on whether a pension pot had been crystallised or not. Following the changes, the deciding factor when looking at the tax treatment of a pension fund on death is the age of the person who dies.

Nominating a Beneficiary

An individual can ask their pension provider if they can nominate someone to get money from their pension pot when they die.

Most defined contribution pensions can be inherited by anyone on death, it doesn’t have to be a spouse or civil partner. If you inherit a defined contribution pension pot, you too can nominate someone to inherit any monies that you don’t use before you die, assuming the pot is in a flexi-access drawdown fund.

A defined benefit pension pot is a little more restrictive in that it can usually only be paid to a dependant of the person who died i.e. husband, wife, civil partner or child under 23. If it is paid to someone else it will be deemed to be an unauthorised payment and will be taxed at 55%.

When Tax is Payable

Whether tax is payable when you inherit a pension depends on the age of the pension owner on death, the type of pot received and the way the funds are paid to the beneficiary i.e. lump sum, annuity etc.

A summary of the tax charges in each scenario is outlined below:

Tax Factsheet - Death Benefits and Tax

As the summary highlights, the majority of pension pots received from an individual who died before they were 75 are tax-free. There are certain instances where this may not be the case.

Payments more than two years after the provider is told of the death

If a pension payment is received two years after the provider is told of the death, income tax will be payable if the beneficiary receives either:

  • A lump sum from a defined benefit or defined contribution pot
  • An annuity or drawdown fund from a pension pot that is ‘untouched’ i.e. no money has been taken from it.

Where tax is payable, the provider should deduct the applicable charge prior to paying the funds to the beneficiary.

The pension savings of the person who died are worth more than £1,030,000

A tax charge will apply to a pension pot received and worth more than £1,030,000 if all the of the criteria below apply:

  • The pension pot is untouched
  • The pot was received within two years of the provider being told about the death
  • If, when the value of the pension pot received on death is combined with the beneficiary’s other untouched pension savings, the total is more than what’s left of the person’s lifetime allowance.
  • There is no fixed protection in place with HMRC

In these circumstances, the individual receiving the pension on death will pay tax at a rate of 55% on any lump sum and 25% on any other payment such as an annuity or money from a drawdown fund.

Any tax due will be requested for payment by HMRC. They will do this once they have been notified by the executors of the estate.

The individuals dealing the deceased estate have an obligation to notify HMRC that tax is payable by the beneficiary within 13 months of the death or 30 days after they realise tax is owed.

Annuities where the donor died before 3 December 2004

Where a beneficiary receives an annuity where the owner died before December 2004, income tax will be deducted from the payment by the provider in the same way deductions are made where the donor is over 75.

IHT implications for the beneficiary

Most lump sum death benefits relating to personal and occupational pensions are payable at the discretion of the scheme provider or trustees and as such there are no IHT implications.

Equally, any payments made to surviving spouses, civil partners or financial dependants won’t suffer any IHT charge in any case.

Occasionally HMRC may consider IHT where contributions were made into the scheme of there was a transfer of pension benefits by the donor in the two years prior to their death, whilst they were in ill health. They may also look into the payment if a binding nomination was made i.e. the member gave written direction to the make the payment to a particular beneficiary and has absolute discretion as to who that person might be.

This factsheet is based on law and HMRC practice at July 2018.

For more information contact Richard Major on 0113 396 0115 or 07782 274 754 or email richard@dswprivateclient.com.

Death Benefits and Tax

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