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Why scheme benefits should not be viewed as falling outside of financial planning

29 May 2018

Moira Warner, technical manager, Prudential uses a case study to examine the use of scheme arrangements as part of wider financial planning

Death is not the end. This truism can apply equally on death of the member as in life. So it would be a mistake to assume that scheme benefits are what they are and as such fall outside planning considerations.

Rather, where the opportunity exists, death provisions can be used as part of wider planning designed to ensure loved ones are appropriately provided for on death. The point is perhaps best illustrated by an example.

Case study: client profile

Paul is a 57-year-old surgeon and an active member of the 1995 section of the NHS Pension Scheme. He is divorced and has two adult children from that marriage. He has been living with his current partner Sophie for 13 years and has one further school-aged daughter from that relationship. In addition to his NHS benefits, Paul has a personal pension with a value of £160,000. His total benefits have a value of £1,277,000 and he has valid IP16 protection.

The benefits payable

The adviser is aware that the NHS Pension Scheme provides the following benefits in the event of Paul’s death as an active member with more than two years’ service:

  • A lump sum of 2 x Paul’s annual pensionable pay . This is payable regardless of length of service
  • An adult dependant’s short-term pension payable for 6 months at the rate of Paul’s pensionable pay where this provides a higher rate than the long-term pension described below
  • An adult dependant’s long-term pension. The rate at which this would be payable depends on whether Paul was aged over 60 (normal pension age in the 1995 Section) at date of death. If under age 60, this element of pension will be 50% of Paul’s notional Tier 2 ill-health pension. (Tier 2 pension provides benefit entitlement of membership built up plus an enhancement of two thirds of prospective membership to age 60). If aged over 60 the long-term pension will be 50% of Paul’s notional retirement pension. The long-term pension begins when the short-term pension ceases. The adviser is also aware that the long-term pension will be based only on Paul’s membership from 6April 1988 if it is paid to any surviving adult other than a widow.
  • A short-term children’s pension payable at the rate of Paul’s pensionable pay for 3 months. If Paul’s partner is not eligible to receive an adult dependent’s pension, Paul’s eligible children would receive this short-term pension for 6 months
  • A long-term children’s pension payable at a rate equal to 50% of Paul’s notional Tier 2 ill-health pension divided between them. As only 1 of Paul’s children is eligible to receive a pension then this is paid at a rate of 25% of Paul’s notional Tier 2 ill-health pension.

The benefits described above apply to Paul who is in active service in the 1995 Section. They will not apply to all members. In particular, benefits will vary for deferred or pensioner members and those who are members of the 2008 final salary section or the 2015 career average scheme or who have mixed final salary and career average service.

Aims & recommendations

Paul is keen to minimise tax and ensure his pension money stays within his bloodline whilst ensuring that his current partner is provided for. The adviser assesses Paul’s current arrangements and advises as follows:

1. Paul’s relationship with his new partner meets the eligibility criteria for an adult dependent’s pension to be payable on his death as they are financially inter-dependent, are free to form a legalized relationship and have been co-habiting for at least two years. However, scheme regulations require that Paul nominates his partner to receive this pension. Although the case of Denise Brewster has called into question whether such nominations remain necessary, the matter remains uncertain and the adviser considers it appropriate to bring some certainty to the situation. He therefore recommends that Paul completes the nomination form available on the NHS pensions website to ensure Sophie receives short and long-term pensions in the event of his death. As Paul has service after 1 April 2008, this pension will continue to be paid even if Sophie marries or co-habits with someone else. As Paul commenced pensionable NHS employment in September 1985, 2.5 years of his service won’t count towards any survivor pension paid to Sophie as she is not technically a widow.

2. Disbursement of the NHS lump sum falls under separate arrangements from any nomination relating to the adult dependent’s pension. The adviser informs Paul that if he doesn’t nominate a beneficiary to receive the lump sum, this death benefit will be paid automatically to Sophie but only if he has previously nominated her to receive the adult dependent’s pension. If he doesn’t do so then the lump sum death benefit will be paid to his Estate. The NHS scheme has no discretion to decide on the beneficiary of any death benefits meaning that they cannot decide to make any part of the payment to Paul’s children unless Paul nominates them. It also means that payment will be assessable for IHT. Under NHS scheme rules Paul can nominate as many individuals as he likes to receive the lump sum or he can nominate a single incorporated/unincorporated body. Paul’s adviser recommends that he establish a spousal bypass trust (SBT) and that he nominates this trust to receive the NHS lump sum death benefit.

3. Distribution of death benefits from Paul’s personal pension is discretionary, so Paul can express a wish that in the event of his death the lump sum death benefit is also paid to the SBT. This arrangement has a number of advantages:

a. As long as the trustees of the SBT distribute the funds in line with Paul’s instructions, he can ensure that funds are used for the benefit of Sophie (for example for the duration of her lifetime or earlier remarriage) and his children and thereafter to grandchildren etc.

b. Depending on Paul’s wishes, it may be possible for the trustees to manage disbursement in a tax-efficient way. Tax treatment will depend on whether Paul dies before or after reaching age 75 .

i.If Paul is under age 75 at date of death the Lump Sum Death Benefit will normally be paid to the trustees tax-free subject to the LTA.

ii. If Paul is aged 75 or over at date of death a special lump sum death benefit charge of 45% will apply to the payment made to the trustees. However, when the trustees make a distribution from the trust, that payments will be treated as the income of the beneficiary, and the 45% tax charge to the trust can be offset against the beneficiary’s liability to income tax.

c. It allows trustees the flexibility to tailor distribution according to Paul’s circumstances at the date of death. (NHS death benefits differ depending on whether death occurs in service, in deferment or as a pensioner).

d. In the event Paul’s circumstances change or he changes his mind he can simply revoke his NHS nomination and re-nominate and/or complete a new Expression of Wishes in respect of his personal pension.

4. Both of Paul’s adult children are aged over 23 and working, so only Paul’s daughter from his relationship with Sophie is entitled to a children’s pension under NHS scheme rules. She will continue to be eligible for a children’s pension until she’s 23 or until she ceases to be dependent on Paul, if earlier.

5. Paul’s adviser also recommends that he consider allocating part of his NHS pension in favour of Sophie or their young daughter. In the event of Paul’s death, this will provide additional income over and above the standard NHS survivor benefits and will also reduce the value of Paul’s benefits for LTA purposes. However the adviser points out that once Paul’s daughter reaches age 23 any scheme pension paid to her under an allocation election will become unauthorised and subject to a 40% charge on each payment. Paul is unable to apply to allocate pension until he claims his benefits, so agrees to revisit this idea with his adviser ahead of his expected retirement at age 60.

What it means for planning

Public service pension scheme regulations set out the benefits which are payable which typically include a lump sum death benefit and pensions for adult survivors and eligible children. Despite recent high-profile cases, advisers should not rely on survivor pensions being paid to co-habiting partners who are otherwise eligible unless a nomination is in place (where one is required under scheme rules). Members are frequently able to nominate or express a wish separately in respect of the lump sum death benefit and this should not be confused with any continuing requirement to nominate a co-habiting partner for adult survivor pension purposes. Finally, advisers would do well to understand whether any element of scheme discretion applies to distribution arrangements. Binding nominations can survive remarriage or divorce so it’s important that your clients keep their nominations up to date.

Death isn’t the end for bereaved families. So sensibly the benefits which may be paid out to them by public service pension schemes should be the starting point of ensuring they are adequately protected on death of a client employed in this sector.