Lifetime allowance reluctant to release its death grip (Birmingham Post article 25.05.2023)

It is important to understand what will happen to your pension when you die, and what the tax implications will be of handing it on.

How your workplace pension or one you’ve set up yourself might be paid to your beneficiaries.

As with anyone who passes, the process of winding up his or her affairs is often protracted.

Now it could go from slow to snail’s pace as HM Revenue & Customs introduces a new processing method ahead of the imminent abolition of the lifetime allowance announced in the Budget.

All depends on what type of pension you have.

A defined benefit pension pays a retirement income based on your salary and the length of time you were a member of your employer’s pension scheme. Defined benefit pensions include ‘final salary’ and ‘career average’ schemes. A defined contribution pension allows you to build up a pension pot to pay you a retirement income based on how much you and/or your employer contribute and how much this grows. This is also known as a ‘money purchase’ scheme. They include workplace and personal pensions.

MoneyHelper notes: “If you have a defined benefit pension, any money to be paid to your beneficiaries will be as outlined in the scheme’s rules.

“Your pension administrator might pay a dependant’s pension to your spouse or civil partner; your child(ren), providing they are under the age of 23 and in full-time education; your child(ren), regardless of age, if they’re mentally or physically impaired; anyone who was financially dependent on you (or where you both relied on each other financially) when you died.

“The pension they will get will be a percentage of the pension you were getting (or would have got if you die before your pension started being paid). Any income paid to a dependant will be taxed as earnings at their marginal rate.”

It’s more complicated with defined contribution pensions. Beneficiaries have a choice.

If no money has been taken from the pension when you die, they can usually withdraw all of it as a lump sum, set up a guaranteed income (an annuity) with the proceeds or, establish a flexible retirement income (pension drawdown). If you’ve chosen to take a flexible retirement income and are in pension drawdown when you die, your beneficiaries can take the remaining money left and set up similar arrangements.

MoneyHelper goes on: “If you die before you’re 75, anyone who inherits your defined contribution pension fund won’t pay any tax. If you die after 75, anyone who inherits will be taxed on any income received as earnings at their marginal rate. In most cases, any pensions you have can be passed outside of your estate and so won’t be subject to inheritance tax.”

Trouble is that HMRC changes in response to the scrapping of the lifetime allowance could clog the system, Jon Greer, head of retirement planning at Quilter, told FTAdviser.

According to an HMRC newsletter, these mean that lump sum payments from pensions on death, which would have been subject to a lifetime allowance excess charge, will in the meantime be liable for income tax at the recipient’s marginal rate.

The changes place the onus on the beneficiaries or solicitors to determine and relay the apportionment of a tax charge to the pension provider, and then the provider is required to deduct the tax from the excess above the lifetime allowance prior to making the payment.

This could cause complications and delay pension death benefit payments in the interim – the lifetime allowance will be abolished entirely from April 2024.

For most of us, it can’t come soon enough!