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Paying death benefits to an estate

15/05/2024

On the death of a member, pension schemes will sometimes pay death benefits to the deceased members estate. This can be for various reasons. For instance:

  • The deceased may have nominated the estate, believing their Will (or the rules of intestacy) adequately reflects their wishes.
  • The deceased may not have left a valid nomination and there is no beneficiary with a clear claim.
  • Where there are numerous beneficiaries and the nomination matches the Will (or intestacy rules) - This can reduce administration for the scheme and be simpler for the beneficiaries, who only need to deal with the personal representatives. 
  • In some instances, the scheme or product rules will not cater for discretion and the estate is paid the death benefits as of right. 

The form of death benefits when paying to an estate

When paying a pension to an estate, a lump sum is normally the only option. It will not be possible for the death benefit to be paid as a scheme pension, annuity or drawdown death benefit. 

This is because the estate is not an individual and cannot qualify as a dependant, nominee or successor (FA2004, S28, Part 2). This would also be the case for an individual paid in their capacity as a personal representative – an executor or legal representative.

The exception to this rule is where a scheme pension or annuity holds a minimum guaranteed period (a ‘term certain’) payable on death. A guarantee period can be paid to a non-individual and unlike other pension death benefits, can be assigned to a new beneficiary at a later point.

The tax position

Inheritance tax - Where discretion is used, paying the estate won’t result in the fund forming part of the estate for inheritance tax purposes. This is confirmed in IHT17052 where it states:

‘Where pension scheme providers have discretion over the payment of death benefits, and the member could not have created a situation where scheme providers had no discretion, the payment is not treated as part of the estate whether or not any letter of wishes is followed. This is the case even where discretion is exercised in favour of the estate or the personal representatives’ 

Tax on death after age 75 - Where a lump sum is paid to a non-individual, discretionary trust or personal representative on death after age 75, the payment is subject to the Special Lump Sum Death Benefits Charge (SLSDBC) of 45%. 

However, unlike beneficiaries of a discretionary trust, who benefit from an income tax credit equal to the 45% tax charge, there is no such tax credit available to the ultimate beneficiaries if the lump sum is paid to personal representatives of an estate.

Tax on death before 75 – The tax position on death before 75 depends on how much of the deceased member’s ‘lump sum & death benefit allowance’ (LSDBA) is remaining and when the payment is made: 

  • Lump sum payment within the deceased’s LSDBA - The lump sum benefit would be tested against the deceased’s remaining LSDBA. If the payment does not exceed the LSDBA and the lump sum is paid within two years of death, no income tax should be due on the payment. This would mean that the payment can be distributed to the personal representative’s tax free.
  • Lump sum payment exceeds the deceased’s LSDBA - The excess over the deceased’s remaining LSDBA would be taxed as pension income. For non-qualifying persons who are not subject to the higher or additional rates of income tax (such as a personal representative), this will be basic rate tax.
  • Lump sum payment not paid within 2 years of notification of death - If the lump sum is not paid before the end of the relevant 2-year period, then the whole of the lump sum is subject to the special lump sum death benefit charge of 45%. 

Could the beneficiary of the estate ever reclaim the 45% SLSDBC tax charge?

Some Wills are set up to create a Will Trust. It may therefore be possible to pay the pension to the personal representatives in their capacity as trustees of the Will Trust, rather than in their capacity as executors of the estate. This would allow the eventual beneficiaries to benefit from a 45% tax credit when the pension is distributed. However, it wouldn’t be possible to do this with more simple

Wills or where the scheme member died intestate (without a valid Will).

The alternative approach would be to pay each beneficiary their share of the lump sum directly. This would mean each beneficiary would be charged income tax on their share, rather than the 45% SLSDBC. However, the scheme might not be willing to do this, especially if there are many beneficiaries. 

To cater for this, the scheme would need to collect names, addresses, NI no’s, dates of birth and bank information for each beneficiary, before creating individual pension records so that the payments can be reported and taxed under Real-Time Information (RTI).

Comment

Although nominating the estate may in some circumstances seem like a sensible idea, it can have drawbacks in relation to tax: 

  • The ultimate beneficiaries of the estate are likely to lose the option of a drawdown or annuity – this would allow income to be spread across multiple tax years and the fund to grow in a largely tax-free environment.
  • It can greatly increase the tax chargeable, especially if beneficiaries are nil rate or basic rate taxpayers – the SLSDBC charge of 45% will be higher than income tax for all but additional rate taxpayers. 

Before simply nominating the estate, it is therefore advisable to consider carefully who should receive the pension fund on death and how. Where there are many beneficiaries or circumstances are more complicated, it may be worth considering the use of a Trust* rather than the estate, as a means of distributing a pension fund on death. 

Even when nominating the estate, it is widely recommended that members make secondary nominations for any family members or friends that potentially could be a future beneficiary. This ensures that these people will qualify as ‘nominees’ and enable the full range of death benefit options to be available.

* Our by-pass trust and supporting documentation can be found here.

Important information

Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.

The use of this document is at your own risk, and the content should not be used for the provision of professional advice.

LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.