What’s in a word? Direction or discretion?03 July 2017
They sound like fairly innocuous words don't they - direction or discretion? In many situations, you might be quite happy to leave a death benefits decision to the discretion of someone you trust. However, you might be quite surprised at the difference it could make to the tax take from your pension pots if you die – two very similar words, however possibly two very different tax outcomes.
Care needs to be taken and this raises the question:
How do pension death benefits work?
Money purchase / Personal pension type arrangement
Under a money purchase / personal pension type arrangement, on your death before the age of 75, the value of your pension pot can be paid as a lump sum (or a drawdown pension if the provider allows this) to any beneficiary free of any tax. On death after the age of 75, the value of the fund or a drawdown pension can be paid to any beneficiary and will be taxed at the beneficiary's highest marginal rate of income tax.
Your pension provider will be able to tell you how to put a death nomination in place, and this is usually either through a form or a letter to the provider. It's really worth doing, to ensure that the pension provider is aware of the people you want to benefit if you die.
You could fairly argue that this is a way of providing free life cover to your loved ones while the pension fund remains in place and undrawn.
You have two options (which are usually detailed on the nomination form). It's important to decide what you want and to go for the one that is right for you:
- Allowing the pension scheme administrator the ultimate say over who gets the death benefits of your pension plan (discretion). This would usually mean that the value of your pension pot will fall outside your estate for inheritance tax purposes and the funds should normally be available to your beneficiary/beneficiaries tax-free quite quickly. Pension scheme trustees will have a 'common-sense' approach and would usually pay the death benefits to whoever you've nominated. However, if there's a real anomaly (e.g. spouse and kids have been left out and need the cash) they are likely to raise questions and may change the direction of your original wishes.
- Instructing the administrator / trustees exactly who should receive the death benefits of your pension plan, without giving them any choice (direction). This means that the death benefits will be paid out exactly as you instruct and they may be subject to inheritance tax. This won't always be the case, but unless you have a specific reason for wanting to put in place a binding instruction, it can be sensible to go for discretion rather than direction. This is because with direction, the death benefits may be taxed.
An additional note
One final important point is that if you change your instructions and die within two years of achieving the change, HMRC reserves the right to check the change to ensure that it was not made with the deliberate aim of reducing any tax they may otherwise have received.
Final Salary/ Defined Benefit arrangement
The death benefits from this type of plan are likely to vary dependent on the scheme, but may include a pension, death in service payment and return of your pension contributions.
It is worth checking with the scheme to see how these add up to ensure that you maintain the protection you require for your family and loved ones.
You can update your nominations at any time, so if your relationships / circumstances / wishes change then make sure you update your pension provider. And check your current nominations – you might find you forgot to arrange one for a pension you started ages ago, or you might even find that it's nominated to someone who is no longer in your life and who you wouldn't want to benefit now.
We would recommend that you have a look at your old paperwork for nominees and if you can't find it, make new nominations – a few minutes' work now could make a big difference to your loved ones in the future.
No individual advice is provided during this blog.
Vicky Fulcher Dip PFS
Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.