Death benefits
If a client dies at any point from their 75th birthday, there is no LTA test, but the beneficiaries will pay income tax on those funds at their marginal rate. (This also applies if the client dies before age 75 but the funds are not designated for two years.)
If a client dies before the age of 75, it is the other way round. Any uncrystallised funds paid out as death benefits are tested against the LTA of the deceased client. (Death benefits paid from drawdown funds are not tested against the LTA). However, they are free from income tax.
This applies whether the funds are taken as a lump sum or as a beneficiary’s pension. It is this aspect I want to focus on as this is where we have seen a change in the rules.
The LTA tests still take place, and it is the responsibility of the client’s legal personal representatives (LPRs) to determine whether the value of the death benefits exceeded the client’s remaining LTA. If it has, the beneficiaries will now pay income tax on the excess rather than an LTA charge.
HMRC initially indicated that from April 6 2023 providers would be required to deduct the income tax via PAYE. This represented a change in process from before when the LPRs would notify HMRC, and HMRC would assess the beneficiaries for an LTA charge.
However, this would have been fraught with complications, and HMRC took on board feedback from the industry and reverted to the previous approach.
The LPRs will send LTA info to HMRC. HMRC will then assess the beneficiaries for income tax. As far as we are aware, this will still be apportioned on a ‘just and reasonable’ basis if being split between multiple beneficiaries.
Beneficiaries who are dependants, nominees or successors can choose to take the death benefits as a lump sum or a beneficiary’s pension. If the funds were uncrystallised, the lump sum would be subject to an LTA test. If there is an LTA excess, they will pay income tax on those funds.
From a planning perspective, therefore, they may well be advised to take the pension option in LTA excess situations so they can manage the income tax liability over time, taking into account their personal allowance.
This was already a more appealing option for post-75 death benefits. That now applies to pre-75 death benefits too, where there is an LTA excess.
Some beneficiaries will not fall into this basket. The most common example is family members, such as grandchildren, who were not specifically nominated, but who find themselves receiving the death benefits perhaps because the nominated beneficiaries have died or do not need the money.
