Pensions funds – tax treatment on death

Significant changes have been implemented regarding the tax treatment of pension funds upon death. At AHACCOUNTANTS, we provide expert guidance on the regulations that allow pension funds to pass free of all taxes in the Nottingham area.

Since April 2015, alongside alterations to accessing defined contribution pension funds, the income tax treatment of these funds upon death has also undergone substantial revisions, significantly reducing income tax liabilities. This factsheet outlines the current rules for defined contribution schemes, which may enable a pension fund to transfer free of taxes for both the deceased’s estate and the beneficiaries.

Inheritance Tax (IHT) and Pension Funds

Pension death benefits can be subject to inheritance tax (IHT) if the member has control over the choice of beneficiaries. In such cases, HMRC may consider the death benefits part of the member’s estate for IHT purposes.

However, many pension schemes do not allow members to choose beneficiaries, directing all death benefits to be paid at the discretion of the scheme administrator. Consequently, these benefits may be exempt from IHT. To guide the administrator, it’s essential for members to create a ‘letter of wishes’ to specify the intended recipients of the funds.

It’s important to note that any withdrawals from a pension fund return to the estate and may become subject to IHT.

Income Tax Charges on Pension Funds

Deaths Under Age 75

When an individual dies under 75, their defined contribution pension fund can pass to any person income tax-free, whether the funds are in a drawdown account or untouched. This includes payments to a trust.

The fund can be disbursed as a lump sum to a beneficiary or accessed by the beneficiary through a ‘flexi-access drawdown account.’ This tax treatment applies to pension funds within the Lump Sum and Death Benefit Allowance (LSDBA), set at £1,073,100. Any excess amounts will be taxed at the beneficiary’s marginal rate of income tax upon withdrawal.

For this advantageous treatment to be effective, beneficiaries must be designated within two years of the individual’s death. Otherwise, lump sum payments made after this period will be subject to taxation at the recipient’s marginal rate of income tax.

Deaths from Age 75

Individuals aged 75 or older at death can pass their defined contribution pension fund to any beneficiary, who may withdraw funds as income or a lump sum, taxed at their marginal rate of income tax. Alternatively, benefits can be paid as a lump sum to a trust, which incurs a 45% tax charge.

Tax Treatment of Inherited Annuities

Beneficiaries of individuals who die under the age of 75 with a joint life or guaranteed term annuity can receive any future payments from such policies tax-free. Conversely, if the individual dies at 75 or older, beneficiaries will receive payments subject to their marginal income tax rate.