Drawdown Pension and Death Benefits
If you’ve landed on this article you’re likely keen to understand the tax treatment of income drawdown death benefits and also how your beneficiaries can claim these funds from your drawdown pension on death.
To cover these topics thoroughly, we’ve produced this guide to drawdown pension death benefits and possible tax liabilities for beneficiaries.
We’ll cover the following areas:
- What happens to my drawdown pension when I die?
- How will death benefits be paid to a beneficiary?
- How will death benefits be treated for tax purposes?
- Will death benefits be tested against my lifetime allowance?
- Speak to a pensions expert
What happens to my drawdown pension when I die?
Anyone who is 55 years of age or over and has saved into a defined contribution pension scheme (also known as money purchase) can, at this stage, convert their pension fund into an income drawdown plan and begin using these funds for their retirement.
As imperative as it is to understand how these funds can be used while you’re alive, it’s also important to understand what happens to your drawdown pension when you die and to plan accordingly for that.
The first course of action you need to take is to nominate a beneficiary who you would want to receive your pension drawdown funds after your death. This needs to be documented officially with the pension drawdown scheme administrators and kept up-to-date.
Who can I pass the proceeds to after my death?
In April 2015 the UK government introduced a number of revisions to how pension funds can be accessed, which included changes to income drawdown death benefits.
As a result of these new income drawdown death rules, rather than a spouse or specific family member, you can now nominate anyone to be a beneficiary of your income drawdown death benefits.
There are three types, or ‘classes’, of beneficiary who can be entitled to your income drawdown fund after your death:
A dependent is defined as a spouse, civil partner, a dependent child under the age of 23, or an adult child unable to look after themselves due to mental or physical disabilities. Basically, anyone who is financially dependent upon you at the time of your death.
A nominee can be anyone you choose to nominate – a close friend or relative who is not financially dependent or you could nominate a charity, for example.
A successor is anyone nominated by a dependent or nominee that you originally nominated to receive any drawdown pension death benefits that may still remain when they die.
As the original ‘member’ of the scheme, you are not allowed to choose a successor.
There is no limit to the number of successors that can be nominated, therefore, with large pension funds this money can be passed down through generations and has been referred to as a ‘family pension’.
The distribution of any income drawdown death benefits is at the discretion of the scheme administrator. If you die with no dependents and with no nominee, the administrator will select a nominee. This will also be the case if any of your dependents or nominee do not select a successor.
How will death benefits be paid to a beneficiary?
Under the new Flexi-access drawdown rules, a beneficiary can either take the pension funds straight away or leave the funds invested and access them at a later date if they prefer—exactly the same as a scheme member.
Only dependents and nominees made by you as the original scheme member will be allowed to use the funds as pension income. Any beneficiary given funds at the discretion of the scheme administrator will only be allowed to take this money as a lump sum.
How will death benefits be treated for tax purposes?
Whether you are already drawing a pension or not, there are two ways your income drawdown fund can be treated for tax purposes depending on if you passed away before or after you reach 75 years of age.
What happens if I die before I reach 75?
If you die prior to reaching 75 years of age, and you have not yet accessed your funds for drawdown, your income drawdown death benefits can be paid to a dependant or nominee tax-free—either as a lump sum or through a Flexi-access drawdown, providing the proceeds are paid to them within two years.
If the proceeds are paid after two years, they are treated as income for tax purposes.
If you are already using the funds for drawdown and die before reaching 75, the two-year rule does not apply if a beneficiary uses the funds to purchase an annuity.
What happens if I die after I reach 75?
If you die after reaching 75 years of age any income drawdown funds paid to either a dependant or nominee, as a result of your death, are added to their income and will be taxed at their marginal rate.
Any income drawdown death benefits designated to a trust will be subject to a 45% tax charge. Any distribution subsequently made by a trust will receive a 45% tax credit, which can be offset against a recipient’s income tax liability in the year it is received.
How is income drawdown treated for inheritance tax purposes on death?
Income drawdown death benefits usually have no liability for inheritance tax in the UK. If you have already started accessing your pension pot through drawdown, it may be possible for your beneficiaries to recieve your pot as a tax-free lump sum or take the drawdown payments tax-free
If you’d like to know more about how drawdown pension taxation can be applied upon your death, get in touch and we can arrange for an advisor we work with to explain this in more detail.
Will income drawdown death benefits be tested against my lifetime allowance?
Yes they can be, depending upon your age at the time of your death. If you die before reaching 75, the executor(s) of your estate (not the scheme administrators) are responsible for carrying out this test. If you have exceeded your lifetime allowance, your designated beneficiaries will be liable for any tax charge which is due.
This test only applies if the funds are paid out within two years of your death. If a beneficiary has used these funds to purchase an annuity or Flexi-access drawdown plan, any lifetime allowance charge will be applied at 25%. For lump sums, the charge will be 55%.
No tests are needed if these payments are made beyond two years after your death or if you die after reaching 75 years of age.
If you’d like to understand more about your lifetime pension allowance, make an enquiry and we can arrange for a pensions expert to contact you and discuss in more detail.
Speak to a pensions expert
If you have questions and want to speak to an expert for the right advice on drawdown pensions, call us on 0808 189 0463 or make an enquiry online.