The advantages of beneficiary’s drawdown where a Lifetime Allowance Charge applies on death

A benefit crystallisation even (BCE) and therefore an LTA charge can arise in the following post death scenarios:

• following the payment of a lump sum death benefit (BCE 7);
• on designation of uncrystallised funds for payment of a beneficiary’s flexi-access drawdown pension where the member died aged under 75 and the designation was made within the two-year period (BCE 5C);
• where a member dies before their 75th birthday and uncrystallised funds remaining at death are used to provide entitlement to a beneficiary’s annuity (BCE 5D)(The two-year period referred to above is the period starting on the date on which the scheme administrator first knew of the member’s death or, if earlier, the day when they could first reasonably have been expected to know of it.)

The LTA charge applies regardless of whether or not the recipient is resident or domiciled in the UK. 

The process 

Where a lifetime allowance (LTA) charge occurs as a result of the member’s death the process for paying any charge differs from those that occur during lifetime. On death the liability for the LTA charge falls solely on the beneficiary. 

The scheme administrator will pay the death benefits without deducting an LTA charge. This applies whether the funds are paid as a lump sum, designated as drawdown or used to purchase an annuity.

The personal representatives of the deceased are responsible for determining whether an LTA charge applies.  They do this after the payment of the lump sum, the date of designation or the date the beneficiary becomes entitled to an annuity.

Where the personal representatives identify an LTA charge, they must report this to HMRC.  HMRC will then assess the recipient of any charge due.  The usual LTA charges will apply, i.e. 55% where payment is made as a lump sum or 25% where the funds are used to provide the beneficiary with income. 

More than one payment or beneficiary

Where there is more than one payment or more than one beneficiary any LTA charge is apportioned between them.  For the purposes of calculating the available LTA the BCEs are all treated as occurring simultaneously, immediately before the death of the member and any LTA charge is split between the payments on a pro-rata basis eg if a beneficiary receives 30% of the funds they will be liable for 30% of the LTA charge.  This differs from BCEs that occur during lifetime where the member can choose the order. 

Benefits of beneficiary’s drawdown

Often the LTA charge will be due to death in service payments where there is no option to take drawdown and the 55% charge will therefore apply.

However, in other situations where an LTA charge applies on death there is a clear advantage of opting for beneficiary’s drawdown over a lump sum payment whenever possible.  This is because the LTA charge will then be 25% rather than 55%.  If the beneficiary requires all the funds immediately, they can simply withdraw them all as an income payment.  The beneficiary has the choice of paying a 55% charge on the lump sum or 25% plus zero income tax on the drawdown income. 

Another potential advantage of beneficiary’s drawdown is there is no requirement to pay the LTA charge from the pension funds.  The beneficiary can choose to leave the funds invested in the tax efficient environment.  They can pay the LTA charge from their other funds which can be beneficial for their own inheritance tax (IHT) planning.  The payment of the LTA charge will reduce the value of their estate and ensure the maximum funds remain outside of their estate and within the IHT efficient pension.