If a member of a pension scheme aged 75 or over dies and a lump sum is paid to a personal discretionary or flexible trust (for example, a bypass trust), a 45% special lump sum death benefit charge (SLSDBC) will arise. When all or some of the amount is paid to the beneficiary, they will be taxed on the gross amount but be entitled to a credit for the tax incurred by the trustees.
This raises the question that if someone has a tax liability on other income that is less than the tax credit on the trust payment, can the excess tax be recovered from HMRC? According to the Pension Flexibility in Pension Schemes Newsletter 77, the Finance Act (No. 2) 2015 provides that “the individual will be able to set off the tax paid on the lump sum death benefit by the Scheme Administrator… against the tax due on this trust payment. This may lead to a refund of tax.”
As an example, imagine someone has other taxable income of £10,000 and a £2,000 tax charge. They have received £10,000 from a pension scheme trust on which the 45% SLSDBC has been paid on receipt by the trustees. The £10,000 is treated as a gross payment of £18,182 to them and as having incurred tax of £8,182. Their actual tax bill is £3,636 and they have therefore overpaid by £4,546.
The Finance Act 2004 requires the beneficiary to include the lump sum and tax as pension income, so both are counted as part of total income. In the above example, it would therefore be possible to receive a repayment of £4,546 assuming tax on other income had been paid.
Another issue is the way payment to the beneficiary is attributed to the original payment from scheme administrator to the trustees. For example, a 76-year-old dies and has lump sum death benefits of £100,000. The scheme administrator deducts tax of £45,000, leaving £55,000 for the trustees. The trustees invest this money and it grows to £85,000 after five years. They then make a capital distribution of £10,000 to a beneficiary. How much of this payment is attributed to the original £55,000 payment?
Paula Steele, managing partner at John Lamb Financial Planning, says: “According to HMRC, it is up to the trustees to decide how to attribute the lump sum death benefits within the trust rules. The Finance Act 2004 states that payment of any part of that lump sum received by the beneficiaries is treated as pension income. The treatment can therefore be applied to only part of the payment attributable to the original lump sum or the whole payment.”