Death benefits: what are my family entitled to on my death?
The death benefits payable from pension provision is based on a number of factors, including:
- the type of scheme
- if the death is before or after crystallisation
- if the death is before or after age 75
- are there dependants, as defined by HMRC or the scheme rules
- how are the death benefits to be paid - lump sum and/or income.
The recipient(s) of death benefits are usually chosen at the discretion of the pension scheme trustees or administrator. However, a member/pensionholder can nominate who they wish to receive the benefits, by completing a nomination of beneficiaries form (sometimes called an "expression of wish") and the trustees will usually take this into account.
HMRC definition of a "dependant" is broadly:
- The member's widow(er) or civil partner at the time of the member's death
- A child of the member who is under the age 23 at the time of the member's death
- A child of the member who, in the opinion of the scheme administrator, is dependent on the member, because of physical or mental impairment, at the date of the member's death.
- A person who wasn't married or in a civil partnership, who in the opinion of the scheme administrator is, at the date of the members death:
- Financially dependant on the member
- In a financial relationship of mutual dependency with the member
- Or dependant on the member due to mental or physical impairment.
Pension scheme rules may restrict to a narrower definition of dependant (for example, a younger cessation age for a child's pension).
Legislation effective from 6th April 2015 resulted in a significant change in the options/definitions surrounding death benefits, and how they are taxed. The taxation of death benefits are addressed on our Taxation of Death Benefit article. In this article we will look at the shape of death provision for each scheme type.
Death Benefits - Pre & Post Crystallisation Death Benefits
As stated in the introduction, the type of death benefits provided from pensions depends on a number of factors. Firstly, let's look at the subject in general terms and consider the general shape of death benefits for each of the main product types. As death benefits can vary considerably "pre" and "post" retirement (crystallisation) we will look at these separately.
Pre-crystallisation death benefits
Occupational pension scheme rules will detail what benefits are payable and who would be classed as dependants or beneficiaries (which may be more restrictive than HMRC rules allow).
The benefits provided may include:
- A lump sum death benefit - this can be provided directly from the scheme (where the scheme self-insured the cover) or may be insured through an assurance arrangement. HMRC don't limit the sum that can be paid on death (although there may be tax implications if above the LTA). Generally, the scheme will set an amount of lump sum payable if a member dies before taking retirement benefit (usually expressed as a multiple of salary, for example, 4 times salary).
- Dependants' pensions in the form of
- Pension for spouse, partner, or civil partner
- Children's pension (normally paid to a certain age, longer only in the case of a disabled child)
If there are no dependants (as defined by the scheme rules and/or HMRC rules), a lump sum (in addition to any lump sum death benefits, detailed above) may be payable. Again full details of this are set out in the scheme rules.
On the member's death before crystallisation, any dependant's pension from a defined benefit scheme will usually be based on one of the following:
- A percentage of the member's pension entitlement at the date of death
- A percentage of the member's pension entitlement assuming they had worked until the Normal Retirement Date of the scheme
- A percentage of the member's pension entitlement based on somewhere between the above figures. For example it's common for public sector schemes to add a fixed number of years of service to the member's pension entitlement at the date of death
purchase occupational schemes may also provide lump sum death benefits (payable in addition to the value of the pension fund). The lump sum
- may be calculated as a multiple of earnings (as for defined benefit schemes) or a fixed amount, and
- may have been set at a level that allows scope to buy a dependant's pension (as well paying some lump sum).
- generally, is the value of the uncrystallised fund at the point of death. On death, the pension fund can be used to provide a lump sum death benefit and/or dependant's pension benefits, with the lump sum (up to the member's unused lifetime allowance) being the usual choice (as the lump sum would normally be normally be paid tax-free on death prior to crystallisation).
A member will get details of the death benefits in the pension scheme booklet, yearly statements, or by contacting their scheme trustees. It is important that we identify that the death benefits from scheme pensions (usually from Defined Benefit Schemes) are taxed different than from Defined Benefit arrangements, this is covered with the Taxation of Pensions article.
The death benefits provided by individual plans such as Retirement Annuity Contracts, Personal Pensions, Stakeholder pensions etc. are different from those provided by an Occupational scheme.
Generally, the death benefit from individual pension plans is based on the value of the pension fund at the point of death (as opposed to being defined by the scheme rules). On death pre-crystallisation, the pension fund can be used to provide a lump sum death benefit and/or dependants' income, with the former being the usual choice (as noted within the Taxation of Death Benefits article, both lump sum and income death benefits will usually be paid tax free, up to the Lifetime allowance) if death occurs before age 75 and funds are distributed within 2 years of the scheme becoming aware of the members death. Some older type plans, such as early Retirement Annuity Contracts, build a deferred annuity rather than a fund of money at retirement. For these, the death benefit may be expressed differently (return of premiums, with or without interest, etc.) Alternatively, the "fund equivalent" of a deferred annuity may be calculated.
In the past, it was possible to link additional life cover directly to personal pensions (PPs, Stakeholder and the group versions of these plans). This additional life cover was called Pension Term Assurance and provided a lump sum over and above the value of the pension pot. However, in April 2007, HMRC withdrew tax relief on new pension term assurance. As such, if an individual pension holder's circumstances dictate a need for a lump sum on death, they should address this need outside their pension arrangements. If pension term assurance was linked to an individual pension before April 2007, this additional cover can continue and will provide an additional lump sum on death, depending on the terms and conditions of the policy.
If an employer doesn't provide an occupational type pension scheme for their employees they may provide Group Personal Pension or Group Stakeholder plans. In addition they may provide separate death in service benefit cover, perhaps via a Group Life plan - more of this later.
Uncrystallised Fund Pensions Lump Sum (UFPLS)
It's important to note that if a pensionholder wishes to use UFPLS as a withdrawal method, any funds which have not yet been taken as an UFPLS are still within uncrystallised funds and the death benefit provisions remain as for uncrystallised funds. So if a client elects to take UFPLS, any remaining funds will still be available to provide a lump sum death benefit and/or dependant's pension benefits (with lump sum being the usual choice. Again these would normally be paid tax-free if death occurs before age 75, within the remaining LTA and are distributed within the two year rule).
Post - crystallisation death benefits
The death benefits provided by a pension plan, post-crystallisation, will depend on the terms of the plan. As previously covered, the main options offered at crystallisation may include:
- a scheme pension
- a lifetime annuity
- flexi-access drawdown (or in some cases Capped Drawdown).
The benefit offered at crystallisation depends on the type of scheme, but generally fall into the following:
Post-crystallisation death benefits