Stephen McPhillips: Is Benjamin Franklin still on the money?

There can’t be many sayings that have stood the test of time as well as that of Benjamin Franklin back in 1789 when he stated in a letter “in this world nothing can be said to be certain, except death and taxes.” Indeed, reference to “death and taxes” even pre-dates 1789 according to the history books.

So, over two centuries later, why does the statement still carry weight?

Death – an inevitability

Well, aside from the fact that no-one is immortal, when it comes to retirement planning, a key aspect of most registered pension schemes is that they exist also to provide death benefits in the event of the member’s death – be that death before or after taking retirement benefits.

In fact, for some people, their pension scheme is viewed as purely a death benefit scheme because their intention is never to draw benefits from it during their lifetime.

Regardless, payment of death benefits from registered pension schemes is a key feature of them and it might be the main driver for some in making the decision to save in this way for the future; be it for their own future or for that of their beneficiaries.

The pension freedoms introduced back in April 2015 greatly increased the flexibility around payment of death benefits, provided of course that the pension scheme actually offers some or all of the options afforded under the freedoms – and not all do.

Now onto taxes

A significant part of the attraction of pension scheme death benefits may be the tax treatment of these when they come into payment.

However, matters can start to become complicated on this front and I am quite often asked about this aspect following educational webinars and seminars on the topic.

Brevity demands that this article only scrapes the surface of taxation of death benefits, but there are some key factors that will have a bearing on when (if at all), and in what form, tax will be payable, and indeed by whom. There are a number of variables and it’s no surprise that clients will look to trusted financial advisers and planners for sound guidance on this.

Which taxes?

Depending on the client’s circumstances, a range of potential tax charges might apply. That might seem to fly in the face of what I’ve stated above regarding the attractiveness of death benefit options to clients, but a reality (thankfully, not necessarily a certainty) is that tax charges might apply.

Let’s take inheritance tax (IHT) to start with. Usually, IHT will not be an issue, as death benefits are frequently paid at trustee discretion and do not form part of the deceased member’s estate. That’s not always the case, though, and the “Staveley case” judgement in 2020 provided some helpful points to consider - especially where the member is in ill-health prior to making a pension transfer or switch.

Note also needs to be taken of the deceased member’s lifetime allowance (LTA) position in determining whether an LTA tax charge arises on the value of the accumulated fund. The presence of some form of LTA protection might reduce/negate an LTA tax charge.

Then there’s the question of taxation of the death benefits in the hands of the recipient (assuming any IHT liability has been settled).

On the face of it, things could be quite clear-cut here; if the deceased member hadn’t reached age 75 at the time of death, generally beneficiaries (nominees) who are individuals receive the death benefits and don’t pay tax on them at their marginal rate.

However, that’s not always the case; care needs to be taken with the timing of the designation of death benefits where there’s an excess above the LTA to be dealt with, and also with the timing of the payment of uncrystallised benefits.

In addition, it needs to be borne in mind that different rules apply where the recipient is an entity such as a trust, the member’s estate or a charity.

Of course, where the deceased member had attained age 75 at the time of death, beneficiaries who are individuals pay tax on the benefits at their marginal rate and different rules apply for trusts, the member’s estate and charities.

So, while death is a certainty of life, the question of taxes is a lot less straightforward.

Stephen McPhillips is technical sales director at Dentons Pension Management