The tax treatment of pension death benefits is once again in legislative focus.

Tax, pensions and death have all been in the news recently, following the release in July of draft legislation and an HMRC consultation paper.

The current version of the rules came into force on 6 April 2023. For personal pensions and other money purchase (defined contributions) arrangements:

• Generally, all death benefits are free of inheritance tax (IHT), regardless of the age at death.
• If the original pension scheme member dies before age 75, any lump sum payment is income tax-free provided it is less than the individual’s available lifetime allowance (LTA). Any excess is taxable as income for the recipient. No such LTA restriction applies on subsequent pre-75 deaths of beneficiaries/nominees. If, alternatively, income benefits are chosen, these are normally income tax-free.
• On death at or after age 75, both lump sums and income benefits are subject to income tax in the hands of the beneficiaries If a lump sum is paid to a trust, then 45% income tax applies.

Proposed Changes

The July proposals, which would take effect from 6 April 2024, alter the rules if death occurs before age 75:

• The lump sum payment would be subject to income tax for beneficiaries to the extent that it was greater than the pre-April 2024 LTA less any lump sum payments made.
• On the downside, the consultation paper suggests that any income benefits should be subject to income tax.

Pension death benefits have become an increasingly important aspect of IHT planning, partly because the IHT nil rate band has been frozen at £325,000 since April 2009 and will remain so until April 2028. Make sure your will is in place, alongside named beneficiaries of your pension death benefits with both reflective of your current circumstances.