Death Benefit Nominations on Pensions

This article highlights how some simple ‘housekeeping’ within your pension arrangements can make a phenomenal difference to your family’s position.

What do you need to know?

Pensions are falling into the estate and will become subject to Inheritance Tax (IHT) from April 2027 and whilst draft legislation is due to be issued later in the year, it is important you review your nominations for when this change is implemented.

Pensions are typically excluded from your estate for IHT purposes (until April 2027) as they are held in Trust. This structure affords us the attractive tax efficiencies within pension wrappers, but it means you don’t technically ‘own’ the underlying assets, the Trustees do and therefore, when making a Will, your pension cannot be bequeathed this way.

We make our wishes regarding our pension pots clear to the Trustees through a death benefit nomination form, also known as an ‘expression of wish’ form, which you can obtain from your pension provider, and this should be regularly reviewed. Although the nomination is not legally binding, it provides a clear expression to the Trustees who you would like to benefit from your pension pot. There is currently no indication this process will be changed from April 2027.

If there is not an expression of wish in place, the Trustees will use their discretion as to who should benefit from the remaining pension pot. This could become slightly murky if you are cohabiting and not married or have recently separated from a partner which are not uncommon circumstances in today’s world. To avoid any doubt, reviewing your nominations regularly should be commonplace.

Death benefit nominations

Income tax implications on inherited pensions are impacted by the member's age upon death, which I have broken down below for nominated beneficiaries.

You may have seen articles which noted the removal of the Lifetime Allowance, which has now been replaced by the individual lump sum allowance (ILSA) and the individual lump sum and death benefit allowance (ILSDBA). It is worth noting only lump sums are tested against the ILSDBA (and then only if they’re paid from funds crystallised after 5 April 2024), not income and there lies the importance of having the current nominations in place. 

If the member is survived by a dependant or has nominated other persons, a beneficiary can only benefit from drawdown if they have been nominated and the pension wrapper facilitates this. Only a lump sum or annuity will be available if they have not been nominated, and the lump sum will be tested against the ILSDBA if paid from funds crystallised after 5 April 2024. If the member leaves residual benefits post age 75, a nominated beneficiary has the opportunity to control how they incur the taxation by controlling when they access the pension; otherwise, they may receive the full amount as a lump sum, which will be taxed at their marginal rate. 

Now there are two main considerations around pension nominations.

• Are my death benefit nominations in place and up-to-date? 
• Does my pension facilitate beneficiary drawdown? 
  • Some pensions will not, and only lump sums will be available, which will be tested against the above allowance as described above in the event of death pre age 75.

Intergenerational benefits

When assessing the structure of your beneficiaries, due to the attractiveness of drawdown moving forward, it may be prudent to consider intergenerational nominations. An example of this could be:

• spouse – 98%
• child 1 – 1%
• child 2 - 1%.

This tiering allows the children to access beneficiary drawdown (if available through the pension scheme) should there be residual pension remaining, i.e., should the spouse not need an income from this arrangement.

This is a key area which should stimulate intergenerational conversations and planning. As you can see from the previous table, post age 75, the pension fund will become taxable at the beneficiary’s marginal rate. 

For a holistic overview, it is worth understanding:

• your IHT position, as transfers to your spouse are exempt from IHT, and this may be more appropriate for your circumstances over integrational nominations from April 2027
• the rates of tax your nominated beneficiaries pay. From 2027, this could result in an element of ‘double taxation’ if both IHT is due on the pension and you are over age 75.

If, for example, your beneficiary is an additional rate taxpayer of 45%, this is a higher rate of tax than IHT currently 40%. If the initial strategy was to retain the pension until death but not touch it due to the IHT efficiency, is it worth accessing some of your pension earlier and consider gifting it if your beneficiary would pay a higher rate of tax? You should also account for your health status, as a financial gift takes seven years to fall outside of your estate unless covered by a gifting exemption.

Summary

It’s easy to overlook death benefit nominations in your personal plan, but as highlighted in this article, ensuring they’re up to date can make a significant difference—after all, you don’t want your pension accidentally going to your ex.

All nominations in lieu of the upcoming legislation changes should be reviewed, and I strongly encourage you to consider the long-term tax implications of how you structure these. Keeping both IHT and income tax implications in mind. 

With regular legislative changes, keeping your financial plan on track is becoming increasingly complex, as demonstrated by the wider implications a simple housekeeping task can generate. If you think your plan could benefit from a holistic review, contact us today.

Do you want to know more about the benefits a pension may present in your personal planning? Read more at Pension contributions: act now to maximise tax efficiency | Crowe Financial Planning UK Limited.