Pension Death Benefit Nominations More Important than Ever18th October 2015
Major British investment companies such as Hargreaves Lansdown or AJ Bell have reported enormous increase in pension death benefit nomination updates since April. The recent reform has changed the rules governing death benefits and their taxation, opening up interesting tax saving opportunities and making the nomination forms more important than ever before.
Pension Death Benefit Nominations Explained
When a pension plan member dies, assets left in the pension plan are passed to their family, typically a spouse or children, in a form of lump sum or income. These are called death benefits. Who exactly receives them depends on a number of factors, but in the end is typically decided by the pension scheme’s trustees or administrators. That said, the member can nominate beneficiaries by submitting a so called “nomination of beneficiaries” or “expression of wish” form. While not legally binding for the trustees, the nominations are usually taken into strong consideration.
April 2015 Changes to Pension Death Benefits
The 2015 reform, which applies to all death benefit payments on or after 6 April 2015, has changed the rules in two key areas.
Firstly, you now have complete freedom over your death benefit nominations. You can choose to pass your pension to anyone you wish, not limited to dependants (typically a spouse or children under 23, as it used to be). You can choose your grandchildren, other relatives or even people outside your family. This now applies to both lump sum and income.
Secondly, the tax treatment of death benefits has become more favourable. The infamous 55% “death tax” has been abolished. The new taxation rules are as follows.
Death before 75
If you die before the age of 75, all death benefits are tax free, regardless of it being paid as a lump sum or income and regardless of the funds being crystallised or uncrystallised. However, the two year rule remains (lump sum must be paid within two years from the member’s death, or from the time when the trustee was notified of the death). Lifetime allowance also still applies.
Death over 75
If you die at 75 or over, the death benefits (when drawn as income) will be taxed as regular income at marginal tax rate of the beneficiary. This is the same as before, but the new freedom over the selection of beneficiaries increases the potential for tax optimization opportunities.
A lump sum, which used to be taxed at 55%, will now be subject to 45% tax. Nevertheless, it is widely expected for this to change and the lump sum might be treated the same as drawdown – taxed at the particular beneficiary’s marginal tax rate.
Review Nominations Regularly
Under the new, more generous and more flexible rules, it is extremely important to review your death benefit nominations regularly and make changes if circumstances change. Common examples of situations which may deserve an update of death benefit nominations include you or an existing beneficiary (such as your spouse) reaching the age of 75, or changes in the income levels and marginal tax rates of existing or potential beneficiaries. For instance, if you are over 75, your children are higher rate taxpayers and your grandchildren are still in college and have little income, it might make sense to nominate the grandchildren to receive part of the pension, as they will be able to draw some of the funds at zero or very low tax rate.
The recent pension changes have turned death benefits into a powerful inheritance planning tool, with the potential to pass wealth to next generations at little or no tax, as long as the nominations are structured effectively.Share: