There is a lot of planning merit in looking at the nature of death benefits paid by an existing defined contribution scheme as part of the initial analysis process. Most schemes will typically provide the following (assuming a return of fund benefit):
The main disadvantages facing the client and their family from holding pension funds under the first option are:
There is however a third issue related to the Lifetime Allowance, which the following case study highlights.
The client, aged 66, has recently put a Defined Benefit pension into payment which was initially worth £42,586 per annum plus a lump sum of £185,000. For the Lifetime Allowance test this was calculated as being £1,036,720 (£42,586 x 20 + lump sum). The necessary Lifetime Allowance tax charge, through commutation of the pension income, has been paid.
The client now has no Lifetime Allowance remaining. There is however an uncrystallised pot worth £56,254 in place which the client is requiring advice on.
In the current format, the pension provider will only pay a benefit on death as a cash lump sum. This would be tested against the lifetime and would, as a lump sum payment, attract the tax charge of 55%. Assuming death were now, the position would be as follows:
£56,254 x 55% = £30,939.70 tax paid
£25,314.30 lump sum paid to beneficiary
The lump sum is not taxed any further as death was prior to the age of 75.
If the client moved their funds to a more flexible provider, the plan could pass to the nominated beneficiary as a nominee drawdown pension. As an income, this would be taxed at 25%:
£56,254 x 25% = £14,063.50 tax paid
£42,190.50 paid to a Nominee Drawdown Pension in the beneficiary’s name
As the client was younger than 75 on death, no further tax is payable on withdrawals made by the beneficiary in respect of their Nominee Drawdown Pension. This has a tax advantage as follows:
Tax paid under the lump sum option: £30,939.70
Tax paid under the Nominee Drawdown option: £14,063.50
Difference: £16,8m/ 76.20
Through a different pension structure, £16,876.20 less tax can be taken from the pension on death.