Key Points

  • New rules came into force on 06 April 2024 which can affect the tax treatment of pension death benefits.
  • Some pension plans can avoid a tax check, but the devil is in the detail.
  • Book a free initial meeting with one of our advisers to see if you are affected by this change.

The New Allowances

Two new pension allowances were introduced on 06 April 2024:

  • The Lump Sum and Death Benefits Allowance (“LSDBA“), which caps how much can be paid out on death as a tax-free lump sum. It is £1,073,100.
  • The Lump Sum Allowance (“LSA“), which caps how much can be taken tax-free from your pension benefits. It is £268,275 (note this is one-quarter, or 25%, of the LSDBA – the relevance of which will be seen later).

Lump sums taken from pension benefits after 06 April 2024, such as tax-free cash, reduce both allowances.

Some people may have a larger LSA and LSDBA than the amounts quoted above. This applies if the pension member has Primary Protection, Enhanced Protection, or one of the Fixed Protections – which are beyond the scope of this post.

Pension benefits prior to the LSA and LSDBA

If you took any pension benefits prior to 06 April 2024, you will not have a full LSA or LSDBA.

Prior to 06 April 2024, the “Lifetime Allowance” was in force. Any pension benefits taken before this date used up a percentage of your Lifetime Allowance. The tests for what used up the Lifetime Allowance were broader than the new tests against the LSA and LSDBA.

Your remaining LSA and LSDBA are calculated based on the remaining percentage of your Lifetime Allowance.

However, this calculation is complicated as it depends on how your pension benefits were taken.

Tax charge on breaches

If the LSA or LSDBA is breached, there is an income tax charge.

The excess amount over the LSA or LSDBA is added to the recipient’s other income (either the pension plan member or the death beneficiary, as relevant).

The tax charge is then 0%, 20%, 40%, or 45% (or a combination of all four), depending on the excess amount and the recipient’s other taxable income.

It is worth noting this is all very different to what happened with a Lifetime Allowance breach, where the tax charge was either 25% plus income tax or 55%, depending on how the excess over the Lifetime Allowance was taken.

So what does this have to do with death benefits

First, I must stress this post only covers personal pension plans – it does not relate to defined benefits pension plans. While defined benefits plans are affected by the LSA and LSDBA, this cannot be addressed by our company and it is beyond the scope of this post.

There are specific types of pension benefit which are tested against the LSDBA. One of these tests is where a “relevant death lump sum” is paid out of a pension plan in respect of a deceased pension plan member.

Here, the devil is in the detail. Something which looks like a relevant lump sum death benefit to a casual observer will not be classed as such, and so it will not be subject to an LSDBA test. This means it will be free from an income tax charge.

So, clearly, for those with a large pension plan, it is important to ensure the pension provider offers a death benefit option which will not be tested against the LSDBA.

Some issues are:

  • Some providers only offer a death benefit option which will be tested against the LSDBA.
  • Where a provider only offers a death benefit option which will be tested against the LSDBA, some will permit a post-death transfer to another provider which offers a non-tested option – but other providers won’t allow such a transfer, and providers are not compelled to do so.
  • Even if a provider offers a death benefit option which will not be tested against the LSDBA, it might not allow a beneficiary to use this option if the pension plan was not set up in a certain way.

We must consider the context in which this issue could arise. It is difficult enough to deal with a death without also having to worry about taxation and the intricacies of pension death benefits.

Also, those with larger pension plans tend to also have other assets, which leaves them potentially vulnerable to other taxes – making a potential tax-free death benefit highly valuable.

What can you do now

As you can probably appreciate, this issue is complex. So you should seek regulated financial advice to assess whether this issue is relevant to your circumstances and, if so, what action should be taken (if any).

In the best case scenario, your provider will offer a good death benefit option and you will have peace of mind that no action needs to be taken.

The good news is the worse case scenario is not too bad – if your provider does not offer a good death benefit option, you simply need to consider whether it is is worthwhile (overall) moving your pension plan to a new provider. Your adviser will weigh up the pros, the cons, and the costs of such a transfer and make a recommendation accordingly.

To book a free initial meeting with one of our advisers, please call 01642 477758 or visit our Contact page.