Pension death benefits
Individuals hoping to leave a flexible legacy to family members from their pension need to check that they have everything in place to make that happen. Trying to achieve this after they have died may be impossible if stuck in a pension scheme which doesn’t offer the new freedoms, or with an outdated death benefit nomination.
Having the availability of the full range of death benefit options from a modern flexible pension and keeping nominations updated as part of regular reviews has increased in importance. And the time to do it is now; as tomorrow could be too late.
Deciding who gets what
The changes to pension death benefit rules should be the prompt for many individuals to stop and think what they would like to happen to any remaining pension fund on their death.
The merits of each of the possible options need to be considered. Are the individual’s loved ones best served by the tax efficiency and flexibility of the new inherited drawdown rules, or is a secure fixed income from a survivors annuity more appealing? Would a lump sum paid to a family member be better directed to a bypass trust where their chosen trustees can control who benefits and when? Just some of the questions which will need answered.
But having determined what individuals would like to happen, focus needs to turn quickly to making sure those wishes can be followed.
Can the existing pension scheme do it?
The first test is to see if the preferred option is available within the current pension scheme. Although the new rules can be applied to all defined contribution (DC) pensions, not every DC pension scheme will adopt them or have the systems in place to offer them. For example, there will be a number of older schemes which cannot offer inherited drawdown and the only income option for someone dying in such a scheme may be an annuity.
There are plans to create a second hand market where individuals can trade in unwanted annuities for a lump sum or to access drawdown. But it is still very early days to know how this will look in practice and the level of value someone might expect.
It’s not just a question of ‘how’ death benefits can be paid. ‘Where’ they can be paid is also important. For example, anyone who would like their death benefits paid as a lump sum to a bypass trust will need to check that their current pension allows this.
Dying while stuck in the wrong pension scheme may mean the individual’s preferred option isn’t available and in some cases there may be no option at all. And it will mostly likely be too late to put things right.
This means it may be necessary to transfer benefits to a scheme which can accommodate their preferences where individuals place importance on the destination of death benefits.
The importance of reviewing nominations
But even where the pension offers all the new freedoms, it’s important to make sure that pension nominations remain up to date and fully reflect the individual’s intentions.
A death benefit nomination helps to guide the scheme trustees/administrators when exercising their discretion. The scheme trustees/administrator will be guided by the last instructions they have received. So it is vitally important that nominations are regularly reviewed. If changes are necessary, the nomination can normally be changed at any time.
It may well be that the changes to who can be nominated for inherited drawdown will be the reason for completing a fresh nomination. The new rules allow for someone who is not dependent upon the deceased to draw an income. But crucially the scheme trustees/administrator cannot exercise their discretion and offer them the inherited drawdown option where there’s also a dependant unless the deceased had nominated them during their lifetime.
For example, George and Brenda are married. George has a grown up daughter Lindsay from a previous relationship. George dies and his SIPP administrators have to exercise their discretion to determine how to pay out the remaining fund in George’s SIPP between Brenda and Lindsay. They could:
- Pay out a lump sum to Brenda and/or Lindsay. There are no restrictions on how they exercise their discretion over a lump sum.
- Set up an inherited drawdown plan for Brenda as she is a dependant.
- As there’s an existing dependant they could only set up an inherited drawdown plan for Lindsay if George has previously nominated her.
Nominations to a bypass trust
Issues can also arise where individuals have set up a bypass trust and completed a nomination for the lump sum to be paid in to it. Some nominations to a bypass trust can be made binding upon the scheme administrator. In such cases the scheme administrator has to pay to the bypass trust and no longer has any discretion to pay to anyone else. Although nominations can be binding they can be revoked simply by completing a fresh one.
In light of the changes individuals will need to determine if a bypass trust is still the right solution for them. If not, the only cost to the individual is the initial amount used to set up the trust, usually a nominal amount of say £10.
Do it now
It’s easy to think that planning pension flexibility can be left until close to retirement. But effective planning needs to ensure the needs of the individual, and their loved ones, are catered for in any circumstance – including the premature death that nobody wants to think about.
Transferring to a flexible pension when health starts to fail can remove all IHT protection from the transferred pot. So do it while the individual is still healthy.
And dying with an out of date nomination may mean the remaining pot can’t be passed to the right beneficiaries, or in the most efficient way. Therefore reviewing nominations now is crucial. As circumstances change, nominations should change to adapt.