As always, there are exceptions: charity lump sum death benefits; trivial commutation lump sum death benefits; and death benefits crystallised before the LTA was abolished are not tested against the LSDBA.
Post-75
Lump sum death benefits paid to a beneficiary following the member’s death on or after age 75, or outside the two-year period, are subject to the beneficiary’s marginal rate of income tax.
Calculation of income tax
In keeping with the pre-April 6 2024 position, lump sum death benefits paid following the member’s death before age 75 are paid in full and the legal representatives of the member calculate the tax due.
This is a consequence of the fact that all death benefits crystallise at the same time and more than one scheme could be paying benefits.
No one scheme, therefore, can be sure how much LSDBA is available for each payment.
This means the legal representatives must calculate how the LSDBA is to be shared amongst the death benefits being paid.
For deaths on or after age 75 this is not an issue as LSDBA does not apply, and so the scheme deducts income tax from the payment using either the beneficiary’s tax code or the appropriate emergency code.
Income death benefits
Instead of a lump sum, it is often possible to pay death benefits in the form of an income. For DC schemes, this usually means designating to beneficiary drawdown or purchasing a beneficiary’s annuity.
We will start with drawdown, which means the member or beneficiary’s unused funds are designated to either a:
- dependant’s flexi-access drawdown fund;
- nominee’s flexi-access drawdown fund; or
- successor’s flexi-access drawdown fund.
We will refer to these collectively as beneficiary flexi-access drawdown, or BFAD.
There are many advantages to establishing a BFAD; in particular, the funds can be left in the tax-privileged pension environment and accessed only when needed.
Until then they are outside of the beneficiary’s taxable estate and investment growth is not subject to income or capital gains tax.
The arrangement can also be set up for those below the normal minimum pension age, including minors, and the income can continue beyond age 23.
Because of these benefits, BFAD has a key role to play in intergenerational pension planning.
Beneficiaries who have had a BFAD account set up in their name should complete their own nomination form to give guidance to the scheme trustees in the event of their death.
And for the avoidance of doubt, as the arrangement holds death benefits it is ring-fenced from the beneficiary’s own retirement funds and so the payment of income does not trigger the money purchase annual allowance (MPAA).
Current legislation requires that a beneficiary is either a dependant or was nominated to receive death benefits to be able to have a BFAD arrangement set up in their name.
