Most pensions, but not all, are subject to a master trust whereby the pension provider acts as trustee and distributes the remaining pension fund in the case of the death of the member to the beneficiaries, for example, the surviving spouse. The trust ensures that the death benefits are paid out efficiently and not generally subject to inheritance tax.
Recent retirement freedoms introduced the concept of ‘nominee’ drawdown income. Since 6th April 2015, you no longer have to be a ‘dependant’ to receive drawdown income on the death of a member. A dependant is classed as a spouse or child under age 23. Nominees are individuals nominated by the member but not necessarily dependants. Importantly, pension scheme administrators (the trustees) can only themselves nominate a beneficiary to receive drawdown if there are no surviving dependants nor nominees of the member. Therefore, if there is a surviving spouse or nominated individual then the trustees would not have this option.
Why is this important?
Nominee income drawdown gives the beneficiaries control of how to use the pension death benefits. For example, they may choose to take a lump sum or hold the benefits within income drawdown from which income may be taken at a time of their choosing which may be helpful for their tax planning. If the beneficiary chooses the drawdown option any remaining pension fund on their death may be payable into a ‘successor’ drawdown plan (a successor is a nominee of the original nominee!). In which it is possible to envisage inheritance ‘cascading down the generations’.
Previously, the death of a member in drawdown (or dependant with drawdown after the member’s death) meant that in the absence of any other surviving dependants, any remaining pension fund could only be paid as a lump sum taxed at 55%. Now, lump sums and income are payable tax free (if the member or dependant in drawdown died before age 75) or at the recipient’s marginal rate of tax (if death occurs at age 75 or over).
So the moral of this is that you should review your pension nominations regularly to ensure that beneficiaries have all options available to them on death of the member. Whilst many pension funds will be paid as a lump sum to a dependant, this does not need to be the case. Beneficiaries can now be chosen by the trustees to receive benefits although where there is a surviving dependant only when a nomination has been made. Equally, it will be important to check whether your pension provider supports nominee (and successor) drawdown otherwise a lump sum will be the only option available.
Pensions are now key to optimal tax and estate planning and nominations are central to this strategy.