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Pension death benefits – who should receive them?

5 September 2020

There are several good tax reasons why an individual might look beyond their spouse in respect of the beneficiaries of their pension, says Fiona Tait, Technical Director, Intelligent Pensions.

The purpose of a pension plan is first and foremost to provide a replacement income in retirement however current circumstances mean that for many the importance of providing for family in the event of unexpected death has risen up the agenda.

The vast majority of clients, quite understandably, are looking to leave their pension plan to their partner/spouse, but there are several good reasons why they should perhaps look beyond this.

Inheritance Tax

The first point is that on death the majority of assets fall into a client’s estate and may be subject to inheritance tax (IHT) unless they are passed to a spouse or civil partner, whereas in the vast majority of cases a pension can be passed to anyone without any IHT liability.

It therefore makes sense, if there are sufficient other assets to support the spouse, to pass the pension fund to someone else the client cares about, such as adult children or grandchildren. They receive it IHT-free and the money is kept out of the spouse’s estate in turn.

If the spouse does need money from the pension to live on this can still be accomplished by using nominee’s Flexi-access drawdown (FAD) or, if required, a bypass trust.

Generational planning

The death benefit options can be really confusing to a spouse, who is likely to be distressed and vulnerable while having to make key decisions, and yet the decision may be simpler for them than it might have been for their spouse as they are less likely to have anyone in their own generation to support.

If there is no other family the choice is similar to the original member’s – lump sum or income, the latter guaranteed or invested. However, if there are other family members the spouse is likely to be focussed on them and the choice is easier – pass on any remaining funds via their estate (lump sum) or via the pension (FAD). The latter is more tax-efficient and potentially also caters for future generations so it would seem a good option for most beneficiary spouses.


Nominee FAD is not without its problems however, for both the original member and the recipient. While the recipient may have doubts about managing the investment the original member may also have been concerned with the fact that their spouse now has control over who gets the money next. In most circumstances they are likely to have the same focus on their joint family, but this is not always the case where step-children and second families are concerned. We often see clients who lay out how they want their funds to be left, to whom, and in what order; however, if they make this directional the funds would then form part of the estate.

This is where the bypass trust comes in. The fund is passed under trustee discretion to a separate trust set up by the member prior to their death, and the member is able to appoint their own trustee to manage it in accordance with their wishes. So long as the spouse is one of the beneficiaries, they can receive a share during their lifetime in the form of a loan, and any remaining funds may be distributed as the member wanted following their death. Catering for the spouse by providing a loan from the trust has the added advantage of creating a debt on the spouse’s estate if IHT is still an issue.

The bypass trust is not for everyone, the periodic tax charges make it less tax-efficient than a simple nomination from the spouse to successor beneficiaries, but it does help to resolve any future arguments between successive beneficiaries.

The age 75 thing

Logical or not, we are still living with the cliff-edge situation whereby if a member dies prior to age 75 the fund may be passed on to the nominated beneficiaries free of tax. If they die having reached 75 the fund will be subject to a tax charge which is based on the income tax position of the recipient.

In many cases this is simply a fact and must be accepted, however in the specific case of a beneficiary who pays higher or additional rate tax it raised the argument of whether they would in fact be better off paying IHT on the transfer of assets rather than the income tax charge. Trusts are also subject to a 45% tax charge which, on the face of it, would seem to outweigh an IHT charge of 40%.

The answer to this conundrum is specific to each client requiring a comparison of the IHT that might be due on the estate with the tax charge that would be due on the pension fund.


Every individual will have different priorities and advisers should help their clients to consider the wider family situation rather than simply passing both the money and the decision-making to their other half.

This article was first published in the September 2020 issue of Professional Paraplanner.

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