Keep it in the family: pension death benefits

We all hope to enjoy the fruits of our labour in retirement having spent our working lives paying into the pension pot.

Few of us take any action to protect our family nest egg from the clutches of the taxman should we pass away prematurely.

This is partly because no-one likes to think they might die before their time or considers the implications this may have for the loved-ones left behind. In addition, most people think their pension plans “belong“ to them. But for tax and estate planning purposes they don’t - they are owned by trustees.

A distinction should also be made between pension benefits to be taken in retirement and a lump sum payable on death before, during or after retirement. Lump sum death benefits do not normally pass under your will but under a separate trust. They may be payable under a personal, or occupational, pension scheme if you die before taking your full benefits.

It may just be a return of contributions paid plus interest and capital growth, but with some schemes there may be extra life insurance cover – a ‘death in service’ benefit. Like personal life policies, pension death benefits should not be viewed in isolation from will making and should be an integral part of estate planning.

In some cases the death benefit can be assigned – or gifted - to a trust in your lifetime, but most schemes provide for it to be held on discretionary trusts for the member's family. You can then tell the administrator who you would like to benefit.

However, if you do not name beneficiaries the lump sum may be paid to your estate and distributed in accordance with your will. “This will result in delay before the cash can be collected by your loved-ones as it can take three to six months to obtain probate,” said David Ainslie, a Partner with Stone King’s Trust, Tax & Probate Team. “It may also trigger an unnecessary inheritance tax (IHT) liability.”

He added: “Although people commonly name a surviving spouse as a beneficiary they seldom allow for their partner dying first, or take advantage of any IHT planning opportunities. With larger lump sums it may be desirable to split the proceeds between a partner and children.

“However, if there is no surviving partner you may not want a large lump sum going to your children at the age of 18. Not only that, but a former spouse may also have a claim on your estate.

“To avoid bringing the lump sum within your estate, the rules of the pension plan may allow a trust to receive the death benefit. This arrangement is commonly referred to as a Pilot Trust or ‘spousal bypass trust’, and allows you to name your surviving partner, any children, charities or others as potential beneficiaries.

“The nature of the death benefit and what can be done with it will depend on whether you die before retirement, or if a pension was being drawn at your death.”

The rules are complex but there is no IHT charge when a Pilot Trust is first set up and payment of a death benefit direct to a trust within two years of death is free of IHT.

If the trust continues it can be subject to IHT every ten years. This periodic charge is calculated at each ten year anniversary of the trust, running from the date you joined the pension scheme. IHT is at just six per cent on the excess value over the £325,000 nil rate band, rather than the full 40 per cent rate.

“Many of us have life insurance policies and pension plans, and often these policies pay substantial death benefits,” concluded David. “We at Stone King can help you to protect these benefits from inheritance tax and ensure that your loved-ones can gain quick access to the proceeds.”

The law and practice referred to in this article or webinar has been paraphrased or summarised. It might not be up-to-date with changes in the law and we do not guarantee the accuracy of any information provided at the time of reading. It should not be construed or relied upon as legal advice in relation to a specific set of circumstances.

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