Life is what happens while we are making other plans. It is a well-worn saying, but it has more than a grain of truth.
Personal circumstances change all the time in different ways. Clients may get married, have children, get divorced, remarry, maybe have more children. And grandchildren may or may not arrive on the scene.
While it is a client’s prerogative to take life as it comes, financial planners need to have an eye on the future at all times. And when it comes to pension death benefits, it pays to ensure death benefit nominations reflect life, not other plans.
Passing on pensions
Death benefits can be paid out in the form of a lump sum or in the form of a pension. Lump sums can be paid to anyone. However, only certain types of beneficiaries can receive a pension, these being ‘dependants’, ‘nominees’ and ‘successors’.
A dependant is typically the client’s spouse or civil partner, or a client’s child under the age of 23. A nominee is a beneficiary who has been nominated by the client on a death benefit nomination. A successor is a beneficiary who has been nominated by a dependant or nominee.
Since the introduction of the pension freedoms rules in April 2015, death benefits are free from tax if the client dies before age 75. However, they will usually be subject to tax at the beneficiary’s marginal rate if the client dies from 75 onwards.
In some cases, it can be more tax-efficient for a beneficiary to receive a pension than a lump sum, and this is one reason why it is important to review nominations, especially from age 75.
Felicity has a Sipp and dies aged 82. She is survived by her husband Andrew, also 82. They have two adult children, Caitlin and Kirsten. Caitlin has two teenage children of her own. Kirsten has one. Felicity’s nomination with her Sipp provider says Andrew 50%, Caitlin 25% and Kirsten 25%.
Felicity was over 75, so the death benefits will be taxable. Andrew and Caitlin are higher rate taxpayers. Kirsten is a basic rate taxpayer. Andrew qualifies as a dependant as he was married to Felicity, while Caitlin and Kirsten qualify as nominees.
When it comes to distributing the death benefits, the provider speaks to Felicity’s personal representatives. Andrew, Caitlin and Kirsten are all in agreement that they would like a sizeable chunk of Felicity’s Sipp to go to the grandchildren in the form of pensions.
This makes sense from a planning perspective. Given that the grandchildren are not likely to be taxpayers for around 10 years, they could receive income tax-free from the pensions up to the personal allowance of £11,500. If managed carefully, they might never pay any tax on the pensions at all, and the funds would be ideal if they go to university.
However, the grandchildren do not qualify as nominees as they were not on the death benefit nomination. This means the pension option is not open to them. The scheme administrator of the Sipp could still opt to pay them a lump sum, but the whole lump sum would be taxed.
Looking back, Felicity could have updated her nomination form when she turned 75 and added her grandchildren to receive a nominal amount, say 1%. This would have been sufficient to bring them into the definition of a nominee, and they could have received a pension effectively tax-free.
The bottom line is that there is a lot of cultural wisdom in sayings, but when it comes to financial planning, this one is best ignored, as 10 minutes of planning could save thousands in tax.