However, if the conditions above are not met, the lump sum would not qualify as a charity lump sum death benefit and therefore not be eligible to be paid as such.
Taxation of death benefits
The tax treatment of death benefits for income tax depends on:
- The age of the deceased on their death.
- Whether or not the funds are designated to the next beneficiary within two years.
Deceased died before age 75
If the pension member dies before the age of 75 and funds are designated to their beneficiary within two years, death benefits will be paid free of income tax – whether taken as a lump sum or flexi-access drawdown.
On the death of a dependant, nominee or successor, it will be their age at death, not that of the original member, that determines whether the death benefits are taxable.
If death benefits are not designated within two years, then the death benefits will usually be taxed. The exception is where the deceased was both under 75 and already in drawdown, and the beneficiary takes the death benefits as pension income. In this instance the two-year rule does not apply.
If the beneficiary takes a lump sum after the two-year period has ended, income tax will apply, or if paid to a trust will be subject to the special lump sum death benefits charge at 45 per cent.
Deceased died age 75 or over
Where the deceased was over 75, a lump sum death benefit or a pension income paid to an individual will be subject to income tax. A lump sum paid to a trust will be subject to the special lump sum death benefits charge at 45 per cent.
Inheritance tax
Pension benefits generally do not fall within the member’s estate when they die. This means that they are usually exempt from IHT. The scheme administrator or trustees will have the final discretion over who to pay the death benefits to.
This is an important requirement because if a nomination is made where the provider is bound to comply this will mean that the amount of the payment falls within the client’s estate and will be liable for IHT.
HMRC’s reasoning for this is because a binding nomination gives the member "a general power that enables them to dispose of the property" – essentially, if a member can direct where the benefits are paid, then IHT could be payable.
LTA
Currently, where a LTA charge occurs because of the member’s death, the process for paying any charge differs from those that occur during lifetime. On death the liability for the LTA charge falls solely on the beneficiary.
Where a member's LTA has been exceeded, the excess fund will be subject to a LTA charge of 55 per cent where paid as a lump sum, or 25 per cent where used to provide income.
