Pension Death Benefits – A Time For Reflection

When George Osborne introduced pension flexibility in April 2015, the ability to take as much as you liked from your pension was an incredible step-change from what had been a relatively constrained benefit-taking structure up to that point. But even this was overshadowed by the change to the treatment of death benefits, and in particular the ability to now pass your death benefits down the generations keeping them out of scope for inheritance tax (IHT). There was a feeling at the time that this was a’ golden age’ which could come to an end at some point in the future and it seems we will reach this point in April 2027. However, much effort has been put into ensuring that wealth is transferred on death as tax efficiently as possible with the funding of pensions as much as possible a prime option in achieving this.

The recent Budget stated that this would end in April 2027 when ‘unspent’ pensions would now form part of an individual’s estate and so no longer be IHT free. This will effectively torpedo a significant number of individuals’ wealth transfer strategies and advisers are going to be called on to reassess these strategies and provide alternative options for efficient wealth transfer.

Whilst the April 2027 changes will mean pensions cease to be the go-to option for wealth transfer, it is worth reviewing how the new world will compare with the current one and indeed the pre-April 2015 regime. The following table is our summary of death benefit taxation of ‘unspent’ pension funds.

Summary of death benefit taxation of ‘unspent’ pension funds

DEATH BENEFIT TYPE	PRE-APRIL 2015	APRIL 2015 – APRIL 2027	POST APRIL 2027
Lump sum (individuals)	No IHT payable Uncrystallised funds - Tax-free up to available LTA - 55% LTA charge on any excess Crystallised funds & death post age 75 - 55% death benefit charge Pre age 75 lump sum uncrystallised funds must be paid within 2 years of death or 55% charge applied	No IHT payable Death under 75 and distributed within 2 years of death Uncrystallised funds - Tested against LTA, 55% charge on any excess (marginal rate income tax of recipient from April 2023) Crystallised funds - Tax-free Death after 75 or under 75 where benefits not distributed within 2 years - All funds taxed at recipient’s marginal income tax rate	IHT payable at 40% of ‘unspent’ pension funds over the IHT threshold Death under 75 and distributed within 2 years of death Tested against LSDBA, excess funds taxed at recipient’s marginal income tax rate Death after 75 or under 75 where benefits not distributed within 2 years - All funds taxed at recipient’s marginal income tax rate
Lump sum (trust)	No IHT payable Uncrystallised funds - Tax-free up to available LTA -55% LTA charge on any excess Crystallised funds & death post age 75 - 55% death benefit charge Pre age 75 lump sum uncrystallised funds must be paid within 2 years of death or 55% charge applied	No IHT payable Death under 75 and distributed within 2 years of death Uncrystallised funds - Tested against LTA, 55% charge on any excess (45% from April 2023) Crystallised funds - Tax-free Death after 75 or under 75 where benefits not distributed within 2 years - All funds taxed at 45%	IHT payable at 40% of ‘unspent’ pension funds over the IHT threshold Death under 75 and distributed within 2 years of death - Tested against LSDBA, excess funds taxed at 45% - Funds crystallised before 6 April 2024 are not included Death after 75 or under 75 where benefits not distributed within 2 years - All funds taxed at 45%
Pension	No IHT payable Only spouse or dependant’s pension available subject to income tax at recipient’s marginal rate.	No IHT payable Death under 75 and distributed within 2 years of death Uncrystallised funds - Tested against LTA, 25% charge on any excess (marginal rate income tax of recipient from April 2023) - Pension withdrawals tax-free Uncrystallised funds - Pension withdrawals tax-free Death after 75 or under 75 where benefits not distributed within 2 years - Pension withdrawals taxed at recipient’s marginal income tax rate	IHT payable at 40% of ‘unspent’ pension funds over the IHT threshold Death under 75 and distributed within 2 years of death - Pension withdrawals tax-free Death after 75 or under 75 where benefits not distributed within 2 years - Pension withdrawals taxed at recipient’s marginal income tax rate

LTA – Lifetime Allowance : LSDBA – Lump Sum Death Benefit Allowance.

The addition of IHT to income tax, where it applies, from April 2027 is a significant increase in the total tax taken from pensions and reinforces the government’s position that pensions are for later life provision rather than intergenerational wealth transfer.

The following article looks at how individuals, whose wealth transfer strategy had been negatively impacted by the Budget changes, could consider using an alternative gifting strategy to maintain the original intention of passing their wealth on in the most tax efficient manner.

All information is based on our understanding and interpretation of applicable law and legislation.

 

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3. Removal of Adviser Purchase Related Fees
4. Platform Health Check
5. Adding Value to family Businesses 
6. LoA Discounted Service 
7. Transact – BlackRock MPS Two Years On!
8. Pensions Death Benefits and a Time For Reflection 
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