Since changes in 2015 to UK pension rules one of the great advantages of a Self-Invested Personal Pension (SIPP) is that they now allow clients to potentially pass on their accrued pension benefits in a tax-efficient way to their nominated beneficiaries on death.
What happens to SIPPs on death?
A client can nominate whoever they wish to receive their SIPP on death, this could be a spouse, children or grandchildren or even an unrelated person if they so wish. In addition, they can also leave some or all of the SIPP to a registered charity.
Death benefits do not need to be nominated to a single person as they can be split in whatever proportion required, so that each of the beneficiaries receives a share of the SIPP scheme. To inform the SIPP scheme trustees of their wishes, clients simply complete a benefit nomination form to do so.
How are the death benefits paid?
Beneficiaries of the SIPP will normally have the choice of taking the pension fund as a lump sum or leaving the fund invested and using it to provide themselves with an income. If they elect to leave the funds invested, they can take income as and when required by way of flexi-drawdown.
What tax will need to be paid?
The income tax treatment of death benefits paid from the SIPP depends on the age of the scheme member at the time of death.
Death occurs before age 75
• If death occurs before age 75 and the pension funds are designated to beneficiaries within two years, then they will be paid tax free.
• If the beneficiaries choose to take income from the fund, they do not need to take the money out within the two-year period but can wait and take income when required. The tax treatment will be the same regardless of whether the beneficiaries opt to take these as a lump sum or an income.
Death occurs before age 75
• If death occurs after age 75 or if they die earlier but the pension funds are not designated within two years, then the death benefits will be taxed.
• Whether the beneficiaries take the benefits as a lump sum or to provide an income, they will be taxed as income when withdrawn.
• If the beneficiary is not an individual, for example a trust, then benefits will be paid as a lump sum and taxed at 45%.
• Payments to a charity on death over age 75 will not be taxed provided the client has nominated the registered charity and also has no surviving dependants.
What happens to the SIPP when a nominated beneficiary dies?
If the nominated beneficiary has not withdrawn the entire pension fund before their own death, then the funds can be passed on again. The beneficiary will be able to nominate successors who they want their fund to go to following their death. These successors will then have the option of taking the funds due to them as a lump sum or using them to provide an income. The tax treatment of these death benefits will depend on the age of the beneficiary who was holding the pension at their death, not on how old the original SIPP member was at the date of their death.
As an example, if a client lives to be 85 and leaves their fund to their son aged 60 then the death benefits payable to the son would be taxed (as death has occurred over age 75). If the son elected to take the benefits as income but the fund had not been drawn down in full before their own subsequent death at age 70 then the remaining fund could be passed on to their successors free of any tax as they have died before age 75.
In practice, it is possible to have unlimited successors and therefore a fund can be passed on for generations until it is exhausted in full. As such, SIPPs can now have an important part to play as part of any estate planning process where advisers want to help clients pass wealth through the family.