TDQ: Case study – inheriting pension death benefits
16 May 2019
When could inheriting pension death benefits be better planned? The Prudential technical team present a scenario
In this case study, Mark has total taxable income of £200,000 (including £100,000 he has taken as an ad-hoc payment from a nominee’s drawdown plan set up from taxable pension death benefits) and an employer pension contribution of £40,000. He is affected by the tapered annual allowance. His threshold income is £200,000 so breaches the limit of £110,000. His adjusted income is £240,000 so breaches the limit of £150,000. At this point he starts to lose £1 of standard annual allowance for every £2 his adjusted income exceeds £150,000, but there is no reduction below £10,000. This leaves Mark with the minimum tapered annual allowance of £10,000.
He has no available carry forward, so this means he has an AA excess of £30,000 and would need to pay a 45% tax charge ie £13,500. This is based on UK rates of tax and the charge would be higher if he lived in Scotland.
Bearing in mind the £100,000 taxable pension death benefits will already have been subject to income tax at Mark’s marginal rate, and caused the loss of his personal allowance, this is a further blow to the value of Mark’s, already depleted, inheritance.
Now, if he knew he wanted to take a lump sum, things could have been so much different. When calculating the threshold and adjusted income figures for the tapered annual allowance, the last stage of those calculations allows you to deduct any taxable lump sum pension death benefits paid directly from the pension scheme settling death benefits.
Lump sum instead of pension
If Mark had taken the £100,000 as a lump sum death benefit, his threshold income would be reduced to £100,000 (below £110,000 limit so no need to work out adjusted income) leaving him with the standard AA of £40,000. No AA excess and no AA charge. He’d still have paid tax on the lump sum of £100,000 at his marginal rate and, based on adjusted net income of £200,000, he’d have lost his personal allowance. But he’d have saved himself from the £13,500 AA excess charge mentioned above.
It may have been that Mark was entitled to a larger total death benefit payment, e.g. say he designated £400,000 to drawdown and took an ad-hoc payment of £100,000 because the provider’s scheme rules only allowed him to choose to take death benefits all as lump sum or all as nominee’s drawdown. Or it may be Mark didn’t realise there would be any knock-on impact of moving his death benefits to drawdown then taking a large one off payment.
If the scheme rules had offered the option of splitting the death benefits, part as a lump sum and part designated to nominee’s drawdown, this could have helped Mark avoid an AA excess.
Taxable lump sum death benefits can be deducted from threshold and adjusted income calculations when working out if a tapered annual allowance applies.
Q.Which of the following taxable death benefit payments are deducted (from threshold and adjusted income) as part of tapered annual allowance sums?