Death Benefits

Question 1

Name two BCEs where death benefits will be tested and in what circumstances they occur:

Answer 1

1. BCE 7 Where a lump sum is paid on the death of the member before age 75 and the lump sum is paid within two years of the members death.
2. BCE 5 C&D These are addtional benefit crystallisation events post April 2015. Occurs when member dies before age 75 and funds are designated to drawdown (5C) or a lifetime annuity (5D) for a beneficiary.

Question 2

Members death before 75, survivors benefits for:

• Scheme pension
  
  • Dependent
  • Nominee
  • Successor

Tax treatment?

Answer 2

Members death before 75, survivors benefits for:

• Scheme pension
  
  • Dependent - income and/ or lump sum available
  • Nominee - N/A
  • Successor - N/A

Tax treatment? Subject to marginal rates regardless of the age of death of the member.

Question 3

Scheme pension guarantee period and income treatment - post 6 April 2015 rules?

Answer 3

• Length of guarantee period can be no longer than 10 years
• Continuing income under the guarantee is taxed as survivor’s pension income under PAYE

Question 4

Scheme pension:

• Income
• PCLS
• MPAA
• Lifetime Allowance

Answer 4

Scheme pension:

• Income
  
  • Level of pension set at outset
  • Can only decrease in limited circumstances outlined by HMRC
  • Taxed as members pension under PAYE
• PCLS
  
  • DB scheme rules will determine level of tax-free PCLS available
  • The member of an MP scheme may be able to select level of TFC available up to a max of 25%
• MPAA
  
  • MPAA is not triggered unless scheme pension is paid out from a money purchase pension with less than 11 other people (including dependents) receiving a scheme pension
• Lifetime Allowance
  
  • BCE 2 used to assess for for scheme crystallisation event
  • PCLS is assessed using BCE 6

Question 5

Death benefits - lump sum from a DB scheme - what can be provided? (2)

Answer 5

• DB scheme can provide either a DB lump sum death benefit: or
• Pension protection lump sum

Member must opt for the LSDB to be paid as a pension protection lump sum. SInce 6 April 2015, a pension protection lump-sum death benefit is subject to the special lump-sum death benefits charge only if the member died after reaching the age of 75.

Question 6

Death benefits from a scheme pension - lump sum - money purchase funded:

• Lump sum options available
• Tax treatment
• Triviality

Answer 6

• Money purchase scheme can provide an pension protection lump sum and annuity protection lump sum
• Lump sums are tax-free provided members death was before age 75 and paid within the 2 year window - no LTA test on the lump sums
• Taxable trivial commutation lump sum death benefit may be payable to any individual entitled to receive the members scheme pension for the remaining part of any guarantee period
• In all other cases the lump sum will be taxable at the recipients marginal rate. However, where income is being received by an individual who is acting in their capacity as a trustee or personal representative, it will be subject to the special lump sum death benefits charge of 45%.

Question 7

What is the HMRC definition of a dependant (broadly)? (4)

Answer 7

• The member’s widow(er) or civil partner at the time of the member’s death
• A child of the member who is under the age 23
• A child of the member who, in the opinion of the scheme administrator, is dependant on the member, because of physical or mental impairment, at the date of the member’s death.
• A person who wasn’t married or in a civil partnership and is not child of the member, who in the opinion of the scheme administrator is, at the date of the member’s death:
  
  • financially dependent on the member
  • in a financial relationship of mutual dependency with the member
  • dependent on the member due to mental or physical impairment.

Question 8

What is a nominee and in what circumstances can scheme trustees select a nominee to receive death benefits? (4)

Answer 8

A nominee is an individual nominated by the member or scheme administrator, who is not a dependant. The scheme can choose a nominee, if:

• the scheme doesn’t have a nominee from the member, but
• there is someone who qualifies as a dependant and
• the scheme considers it inappropriate to pay to the dependant (such as in the case of an estranged spouse), the scheme can pay only a lump sum to a non-dependant, as a dependant exists.

Question 9

What is a successor? (4)

Answer 9

A successor is an individual:

• nominated by a dependant of the member,
• nominated by a nominee of the member,
• nominated by a successor of the member, or
• nominated by the scheme administrator.

Question 10

A lump sum may be paid on the death of the member. If the member is in drawdown then it would be a drawdown lump sum death benefit subject to the following conditions; (2)

Answer 10

• it is paid in respect of either income withdrawal (drawdown) to which a member / dependant / nominee or successor was entitled to be paid at the date of their death,
• it is not a charity lump sum death benefit.

The maximum amount which can be paid is the total of all the assets in drawdown.

If a member has not crystallised funds yet, the lump sum will be an uncrystallised funds lump sum death benefit if it isn’t a charity lump sum death benefit.

Question 11

From 6 April 2015 onwards, to be a dependants’ or nominees’ annuity, the annuity contract must either:

Answer 11

• be purchased from any uncrystallised funds or drawdown fund remaining on the death of the member. It may also be purchased from the drawdown fund of the dependant concerned, or from the flexi-access drawdown of the nominee concerned; or
• be a future dependants’ or nominees’ annuity provided for at the time the member purchased their own lifetime annuity

Question 12

An annuity payable to a successor is a successor’s annuity if: (6)

Answer 12

• the successor becomes entitled to it on or after 6 April 2015,
• it is payable by an insurance company,
• it is payable until the successor’s death or until the earliest of the successor’s marrying, entering into a civil partnership or dying,
• it is purchased after the death of a dependant, nominee or successor of the member (the beneficiary),
• it is purchased using undrawn funds, and
• the beneficiary dies on or after 3 December 2014.

Question 13

Outline the conditions for BCE 5D to be triggered: (3)

Answer 13

A BCE 5D occurs when:

• on or after 6 April 2015 a dependant or nominee becomes entitled to a dependants’ annuity or nominees’ annuity that was purchased using ‘unused uncrystallised funds’ (see below),
• the annuity is payable in respect of the death of a member aged under 75 that occurred on or after 3 December 2014, and
• the dependant or nominee became entitled to the annuity within two years of the day when the scheme administrator first knows (or could reasonably have been expected to know) of the member’s death.

Broadly, unused crystallised funds are sums and assets held under a money purchase arrangement that were uncrystallised immediately before the member’s death, and since the member’s death have not been used not provide an authorised pension death benefit.

As a successors’ annuity can only be purchased from funds which have already crystallised, the purchase is not a BCE.

Question 14

What is the tax treatment of income and lump sum options taken by nominees?

Answer 14

• DC funds taken by a beneficiary as FAD or lifetime pension annuity will be taxed at the beneficiary’s marginal rate as they draw income.
• Lump sums can be paid less a lump sum death benefits tax charge based on the beneficary’s PAYE status as additional income and is taxable. (In April 2015/16 this was previously at a 45% tax rate - this still applies where there payment is made to a trust or personal representative).

Question 15

How does dependant’s/ nominee’s flexi-access drawdown provide an effective estate planning tool?

Answer 15

• Pension assets can be passed down the line, indefinitely, as opposed to a dependant’s scheme pension which will cease upon the death of the dependant.
• Pension assets remain outside of the beneficiaries estate while continuing to access income through FAD or lifetime annuity.

Question 16

Key considerations for scheme administrators and trustees in designating death benefits when no nomination has been made and there are/ are not surviving dependants of the member: (2)

Answer 16

1. It is not possible for a sceme trustee to nominate an individual to receive a nominee’s flexi-access drawdown pension benefit if there is a surviving dependant of the member. Where there are surviving dependants, the scheme can only set up drawdown for someone who is dependant.The trustees can still use their discretion and make lump sum payments to anyone (dependants and/ or other individuals), but can only make the income option to either a dependant or nominee; no one else.
2. Where there are no dependants and no nomination, the scheme can nominate any inidivudal to receive drawdown. The scheme retains existing discretionary powers for lump sum payments.

Question 17

Top ten key points to consider in any assessment/ analysis of nominations:

Answer 17

1. Dependants are always considered as eligible for any income option
2. If there is no nomination (for pension income) dependants come first above anyone else
3. Dependants in the eyes of the family may not always be the same as the definition by scheme rules or legislation
4. If only dependants are nominated then there is only one option for trustees
5. Names dependants and other nominees provide the greatest scope
6. Nominees do not have to take up the option, they can revoke and leave benefits to other nominees, with trustee discretion
7. The ultimate decision is the trustees
8. Nomination is the legal necessity to allow trustees to act widely and appropriately and distribute income and lump sums as appropriate - this applies again where the beneficiary’s of income options can nominate their successors.
9. The expression of wishes is guidance for trustees - it is not legally binding
10. If there is no nomination, the member’s Will and last instructions will be taken into account along with information from the family

Question 18

Which BCE can occur after the member’s 75th birthday? In what circumstances can this arise?

Answer 18

BCE 3

Where a scheme pension in payment is increased at any point beyond both the threshold annual rate and the permitted margin.

The crystallised value is 20 x the additional increase.

• Threshold annual rate - this is exceeded where the current scheme pension in payment exceeds the scheme pension in payment a year earlier by more than the higher of RPI, £250 or 5% (although there can be circumstances where the scheme administrator has agreed a different percentage with HMRC)
• Permitted margin - if the threshold annual rate is exceeded, the scheme pension has to be tested against the permitted margin which, in effect, is an ongoing cost of living increase since the pension came into payment. It’s measured on an annual rate of increase of the higher of 5% or RPI (although, again, there can be circumstances where the scheme administrator has agreed a different percentage with HMRC)

There’s an exemption to cover schemes with 50 or more pensioner members, that give the same rate of increase to all members of a particular class of pensioner, so long as there are at least 20 pensioner members in that particular class. In such circumstances, there’s no BCE 3.

Question 19

When does BCE 7 occur and what does it entail?

Answer 19

Where a lump sum death benefit is paid in respect of the member, either from a defined benefits scheme or from the uncrystallised funds of a money purchase arrangement.

The crystallised value is the amount of lump sum the recipient (or recipients) receives.

BCE 7 only occurs if the member dies before reaching age 75 and the lump sum is paid within two years of the scheme administrator being made aware (or could reasonably have been expected to be aware) of the member’s death.

There’s no BCE 7 if the lump sum is paid out after two years - instead it will be taxed at the recipient’s marginal rate of income tax

Question 20

Why are spousal bypass trusts used?

Answer 20

The main reason that spousal bypass trusts were set up before April 2015 was to receive the payment of lump sum death benefits so that they did not become part of the inheritance tax assessable estate of the intended beneficiaries.

A SBT gives a degree of control over the ultimate destination of the monies accrued in a pension (as the trustees of the member’s trust will control the destination of what was the pension fund money). This is not offered by pensions freedoms, where the member’s dependant or nominee will then nominate a successor via their own expression of wish form.

Careful selection of trustees is imperative.

Question 21

When might IHT apply to pensions?

Answer 21

1. Where the death benefits from the pension are outside of the estate and the payor is in ill health. The underlying principle is that where the member is likely to survive to take their retirement benefits then the payments are for their benefit so are not transfers of value. Accepted practice that contributions made more than two years prior to death are not transfers of value.
2. Where a contribution is made to someone else’s pension, as the benefit will be for another.
3. Payments forming part of death estate i.e a retirement annuity contract where the death benefits had not been assigned to a trust, guarantee payments from an annuity that are payable to the estate, any arrears from an annuity payable on members death.
4. Assignment of benefits into trust while in poor health
5. Transfers between schemes - good health/ two year rule applies. This is a greay area, though generally it is the difference in value of the death benefits and retirement benefits in the receiving scheme.
6. Binding declarations of nomination i.e. the member exercising an unfettered right to nominate a specific recipient of death benefits. (It may be possible to make a binding nomination, without IHT consequences, where it is irrevocable and happens in good health / two years prior to death or where the trustees are bound to pay to a restricted class of dependants, broadly spouses / civil partners and dependants other than through mutual interdependence.)

Question 22

Key difference between Member’s vs Survivor’s triviality?

Answer 22

• Member’s triviality is for DB schemes only and enables the member, assuming the conditions are met, to commute their payments and take their pension as a cash lump sum.
• Survivor’s triviality enables a dependant to commute guarantee payments to a lump sum. This can be applied to DB pension scheme benefits and money purchase benefits.

Question 23

What is the tax treatment of survivor’s trivial commutation lump sum death benefits?

Answer 23

• The whole lump sum is taxable as pension income of the dependant or individual entitled to receive it.
• The pension scheme administrator must apply PAYE to the lump sum payment before paying the lump sum.

The rate of tax on the lump sum is the recipient’s marginal rate of tax for the tax-year in which the lump sum is paid.

Where the lump sum payment is in respect of a pension already in payment to the dependant or individual, the PAYE code already in operation should be used.