Death Benefits
6 October 2023
Income death benefits
Death benefits in a post LTA abolition world caused some consternation when the policy paper was issued as it said all benefits taken in pension form through BCE5C & 5D would now be fully taxable. The draft legislation does not reflect this and HMRC quickly clarified that decisions had still to be made on the treatment of income death benefits. As at time of writing no information is known on the treatment of these benefits.In principle, if we are to align to the current rules as closely as possible, a way will need to be devised so that only income death benefits in excess of the new allowances will get taxed. Fully taxing these benefits would appear to be beyond the policy being implemented. At present income death benefits are tax free.
Conversely, if we are moving to a world where only the tax free element of lump sums are tested and anything else is taxed then it may be that beneficiaries annuities and drawdown will be fully taxed.
Lump sum death benefits
Lump sum death benefits are largely unchanged in the post 5 April 2024 world. Age 75 will still be key as this will be the point where death benefits become taxable. Likewise, if benefits are not set up within 2 years of the scheme reasonably being aware of the members death then those benefits will be taxable.Prior to 75 benefits will still be tax free up to the new Lump Sum and Death Benefit Allowance. Marginal rate tax will apply to any excess.
There is one key change caused by the move to only testing lump sums against allowances. Death benefits paid from crystallised funds e.g. drawdown pots will now be tested against the new limits.
With only any associated tax free cash tested under the new rules it seems logical that as the drawdown pot, for example, has not yet been tested against the limits then the death benefit lump sums will be tested.
Payments to non-qualifying entities
Currently where taxable payments are paid to non-qualifying entities, such as estates and discretionary trusts, the tax is a standalone 45%.Payments in excess of the lump sum and death benefit allowance, and within the 2 year window, paid to trusts and estates will now be subject to marginal rate tax. We await details on how this will work. For example, discretionary trusts are additional rate taxpayers so would then have to pay an extra 25% tax charge to HMRC, would the tax liability flow through to an interest in possession beneficiary?
Any death benefits paid that are subject to tax are not included in the calculation of income limits for the Tapered Annual Allowance.
Defined Benefit death benefits remain unchanged but lump sums are subject to the new limits.
It will now be possible for someone to have died in 2022/23 and payments of benefits being made in 2022/23, 2023/24 and 2024/25. This would involve payments made when LTA was here with an LTA charge of 55%/25%, when LTA was here with a 0% / marginal rate charge and under the new rules. Where there are multiple beneficiaries, HMRC apportion the tax on a just and reasonable basis. At time of writing HMRC have still to confirm how that will be done.
Further clarity required
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the tax treatment of what was BCE 5C and 5D
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transitional rules on crystallised lump sum death benefit payments where funds were crystallised pre April 2024
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how death benefit taxation will be apportioned equitably where there are multiple payments/beneficiaries
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whether scheme administrators will continue to pay out benefits gross and the personal representatives are responsible for tax reporting.
View Death Benefits video here.
