Pass the Pension: Lump Sum Death Benefit vs Beneficiary Drawdown
Pensions are inextricably linked to retirement planning, however they can also serve as powerful vectors for passing monies on to your loved ones in the event of your death, particularly with regard to tax efficiency.
There are two main ways Defined Contribution/Money Purchase pensions can be distributed in the event of your death, though pension providers are by no means obligated to offer them both. It is therefore important that you understand exactly what your current pension can, or cannot do and whether there is merit in moving your pension to a different provider that can offer the options you want.
Lump Sum Death Benefit
The most common option available for Defined Contribution Pensions is a Lump Sum Death Benefit. This provides your beneficiaries with your entire pension fund as a lump sum in the event of your death.
Though it will usually be provided free of inheritance tax, the sum paid out will form part of your beneficiary’s estate and there may be inheritance tax due on it when they in turn come to pass monies on to their own beneficiaries. This may not be an issue if you are expecting your beneficiary to spend all the monies in their lifetime, or if inheritance tax is not a concern for them. However, if your beneficiary already has a large estate and inheritance tax is a concern, a lump sum addition may be unwelcomed, particularly if they are not likely to spend all the death benefits in their lifetime.
Furthermore, if you pass away after age 75 your beneficiaries will be liable to income tax at their marginal rates on the full amount of the lumpsum death benefit in one go. (NB: there would be no income tax if you were to pass away before age 75).
Beneficiary Drawdown allows your pension to simply pass to your beneficiary as-is. This is useful as it means the monies stay inside the pension on death and it is therefore the pension that is passed on, rather than simply the monies from inside it.
This allows your beneficiary to take monies from the pension as and when needed and anything left in the pension on their death can be passed down to their own beneficiaries and in turn their beneficiary’s beneficiaries (and so on…) within the same pension, protected from inheritance tax all the while. The monies also remain protected from Capital Gains Tax and Income Tax on investments within the pension
If you pass away before age 75, there will be no income tax to pay on the beneficiary’s withdrawals from the pension. If you should die after age 75, your beneficiary will only pay income tax on the monies they withdraw from pension, giving them a much higher level of control over their tax liability than would be possible through a Lump Sum Death Benefit.
There is an assumption that since Pension Freedoms came in in 2015, all pensions provide the option to take pension benefits flexibly both in life and on death, however, this is not true. It is up to the discretion of the pension whether to offer flexible options or not. It is therefore very important that you understand the capabilities of your current pension and whether you may need to move your pension elsewhere to get the features you require.
Please note: If you were to use your pension to purchase an annuity or if you have a Final Salary/Defined Benefit pension, you would usually have options available to you with regard to providing an income for your spouse/civil partner and/or dependents in the event of your death, however this article does not seek to explore these areas.
To discuss pensions, retirement or estate planning, please contact Kreston Reeves Financial Planning, part of the Craven Street Wealth group on +44 (0)330 124 1399, or complete our online enquiry form.
The content of this article is for information only and does not constitute formal financial advice. This material is for general information only and does not constitute investment, tax, legal or other forms of advice.
You should not rely on this information to make, or refrain from making any decisions. Always obtain independent, professional advice for your own particular situation.
Kreston Reeves Financial Planning Limited, Independent Financial Advisers. Authorised and regulated by the Financial Conduct Authority.
Subscribe to our newsletters
Our complimentary newsletters and event invitations are designed to provide you with regular updates, insight and guidance.
You can unsubscribe from our email communications at any time by emailing [email protected] or by clicking the 'unsubscribe' link found on all our email newsletters and event invitations.