Pension death benefits, trusts and nominations

Summary

Pension planning is intended to provide your clients with financial security during retirement. As part of that planning, your clients will need to make some important decisions about the distribution of their pension fund if they were to die before reaching their anticipated pension age. This may be a difficult area to discuss with your clients, but it needs to be considered both at the start of a pension plan and during regular reviews over the term of the plan. Your clients' personal circumstances will change over time and they will need to make sure any arrangements put in place remain appropriate. In this article, we look at two of the options your clients may have available to them for lump sum death benefits which may become payable under their personal pension plans – placing their plan under a separate trust or making a nomination.

Facts and analysis

Most UK registered pension schemes are established under a master trust or by deed poll. These schemes will usually have discretion written into the scheme rules which may be used for the distribution of lump sum death benefits which become payable on a member’s death.

Although the provisions of pension schemes and policy terms and conditions will differ, there are usually two options available to members who wish to take steps to ensure that any lump sum death benefits may be distributed in accordance with their wishes.

The member may:

• place their pension plan under a suitable pension trust, appointing their own trustees, or
• nominate a beneficiary or beneficiaries for the scheme administrator (this would be the trustees of a scheme established under trust or the administrator of a scheme set up by deed poll) to consider when exercising their discretion on who should receive any lump sum death benefits.

The two year inheritance tax ‘window’ for registered pension schemes.

HM Revenue & Customs (tax legislation) allow pension scheme administrators a period of up to two years following the member’s death, in which to pay death benefits without applying the normal inheritance tax (IHT) treatment for a discretionary trust i.e. IHT 10 yearly and exit charges.

Trust

• The pension scheme rules and policy terms and conditions may allow the member to place their pension plan under an appropriate separate pension trust.
• If the member has placed their plan under a suitable pension trust, the scheme administrator would not exercise their discretion following the death of the member before retirement benefits are taken, and is obliged to make payment to the trustees appointed by the member.
• In these cases, the two year period may ‘carry over’ to the trustees of the separate trust and, if they in turn pay the benefits to beneficiaries within the two years following the member’s death, there will normally be no IHT tax charges on exit.

Nomination

• As an alternative to placing their plan under a separate pension trust, the member may indicate who they would like to receive any lump sum death benefits by making a nomination. The nomination would be considered by the scheme administrator, along with other potential beneficiaries, when exercising their discretion at the time of the member’s death.
• The two year period will cease to apply when the benefits are distributed by the scheme administrator exercising their discretion under the terms of the scheme rules.

Bear in mind that the provisions of scheme rules, policy terms and conditions, and any separate trust will vary. This article provides generic guidance only and you will need to check the circumstances applying to your clients when considering their options and potential tax liabilities.

Placing a pension plan under a suitable pension trust

Retirement and death benefits will be paid under the terms of a pension scheme’s rules and the policy terms and conditions. This means the decision on who receives any lump sum death benefits usually rests with the scheme administrator.

To retain some control over the potential beneficiaries, it may be possible for the member to place their pension policy under a separate trust. The member would appoint their own trustees to that trust and nominate the potential beneficiaries who may be considered by those trustees.

Trust provisions

• Some providers supply sample trust deeds which may be used for this purpose or your client’s own legal advisers may provide a suitable deed. Trust provisions can vary significantly and it is recommended that appropriate legal advice is sought if your client wishes to place their plan under a separate trust.
• Although the whole pension policy would be placed under the separate trust, the retirement benefits need to remain payable to the same person who was entitled to those benefits under the pension contract i.e. the member. The trust fund will usually be any lump sum death benefits payable on death of the member before purchase of an annuity.
• In order to keep the lump sum death benefits outside the member’s estate:
  
  • the member’s estate or legal personal representatives must not be the sole object of the trust, and
  • the trust should not provide for any beneficial interest to be payable at the member’s direction to the member’s estate or legal personal representatives.

This means the trust provisions need to provide for distribution of the lump sum death benefits to someone other than the member’s own estate.

• The trust needs to be compatible with the scheme rules and policy terms and conditions.
• If the pension policy provides for drawdown income, the trust will need to be suitable for drawdown products and the distribution of crystallised lump sum death benefits.

What happens on a member’s death?

• If the member dies before taking retirement benefits from their pension plan, the scheme administrator will first need to check that no dependant’s benefit has become payable under the scheme rules or policy terms and conditions.
• If there are no specific provisions regarding payment of the death benefits, the scheme administrator may pay the remaining funds as a lump sum death benefit.
• If the scheme administrator is satisfied that the member had placed their plan under a valid trust, they would not exercise their discretion and would make payment of any lump sum death benefits to the trustees of that trust. The trustees, appointed by the member, will then distribute the lump sum benefits in accordance with the terms of their trust provisions.
• As the member will have appointed both the trustees and the potential beneficiaries named in the separate trust, this provides the member with greater certainty over where their lump sum death benefits may be distributed.

Making a nomination (‘expression of wishes’)

• As an alternative to placing their plan under a separate trust, a personal pension scheme member may be able to nominate a beneficiary or beneficiaries for any lump sum death benefits.
• A nomination is not a form of trust and is not binding on the scheme administrator, although it provides an indication of the member’s wishes, at the time the nomination was made. The scheme administrator can then consider the nomination when exercising their discretion under the terms of the scheme rules.

How to make a nomination

• The requirements of different pension schemes may vary. A nomination section may be included in the member’s application form, there may be a stand-alone nomination form or the member may be able to make their nomination via a letter to the scheme administrator.
• The scheme rules will usually refer to a nomination which has been notified to the scheme administrator by the member, prior to the member’s death. A nomination passed to the scheme administrator after the member has died, or made at a later date by the member’s executors (or other third party), may not be valid.
• To ensure the scheme administrator is able to fully exercise their discretion, taking the members circumstances at the time of their death including any nomination into consideration, the details on the nomination need to be as detailed and clear as possible and leave no room for doubt. If the scheme administrator is unable to identify the nominated beneficiary they would be unable to take the member’s wishes into consideration.

What happens on a member’s death?

• The scheme administrator will first need to check whether there are any overriding provisions regarding payment of death benefits in the scheme rules or policy terms and conditions e.g. payment as an income to a surviving spouse. They will also need to check whether the policy has been placed under a suitable pension trust.
• If there is no trust or other provision regarding payment, and the scheme rules provide for discretionary distribution, the scheme administrator will be able to exercise their discretion as to who may receive any lump sum death benefits.
• The scheme rules, or policy terms and conditions, will usually define the extent of discretion which may be exercised by the scheme administrator. For example, the range of discretion may be restricted to:
  • The member’s surviving widow, widower or civil partner,
  • Family members (it is usual for the scheme rules to specify which family members i.e. grandparents, parents and children),
  • A nomination – this may be a person, or the trustees of a trust (e.g. a spousal by-pass trust), notified to the scheme by the member prior to their death,
  • Potential beneficiaries referred to in the member’s will,
  • The member’s estate.
• Bear in mind that the range of potential beneficiaries under your client’s plan may differ from those listed above.
• A nomination is not binding on the scheme administrator. When exercising their discretion, they will need to consider all potential beneficiaries as defined in the scheme rules or policy terms and conditions, including any nomination made by the member.

If discretion is exercised

• If the beneficiaries of any lump sum death benefit are selected by the scheme administrator and are not paid solely at the direction of the member, then the lump sum death benefit is usually treated as falling outside the estate for IHT purposes.

If the scheme administrator is not able to exercise discretion

• If the member had not placed their plan under a suitable pension trust, and the potential beneficiaries provided by the scheme rules are not available eg. if the member had no surviving family members and had not made a nomination, or the nominee had predeceased the member, then the scheme administrator would be unable to exercise their discretion and have no choice other than to make payment to the member’s estate.
• This means the lump sum death benefit would be included in the member’s estate and may be liable to IHT.

Reviewing a nomination

It is recommended that your clients regularly review their nomination to make sure it reflects any changes in their personal circumstances over time. This is particularly important if a nominee dies before your client or if their relationship with a nominee changes.

There are many life events – planned and unplanned – which may trigger a review of a nomination e.g.

• a marriage or civil partnership,
• separation, dissolution or divorce,
• the birth or adoption of a child,
• the death of a nominee

The conditions applying to a nomination and the means of revising nominees may vary between schemes so it is best to check the requirements of your client’s pension arrangements.

Can a nomination be cancelled?

• A nomination is a flexible means of notifying the scheme administrator of a member’s wishes as it can be altered or cancelled at a later date.
• A nomination would be disregarded if the member makes a further nomination or places their policy under a suitable pension trust.
• Placing a plan under a separate trust will over-ride any nomination already made, or made at a later date.

So . . . what are the differences between a nomination and a trust?

• Whether a nomination or trust will be suitable for your client will depend on their personal circumstances. The following table outlines some of the differences between a nomination and trust which your client may wish to consider.
• Scheme rules and policy terms and conditions will differ and it is recommended that your client seeks their own legal advice to make sure any decisions they make are appropriate to their needs.

Nomination - Overview

• The member notifies the scheme administrator of their preferred beneficiaries should any lump sum death benefits become payable under their plan.

• The member may alter their nomination at a later date by notifying the scheme administrator in writing.

• The nomination is not binding on the scheme administrator, although the nominated beneficiaries will be considered when they exercise their discretion.

Individual Trust - Overview

• The member completes a suitable trust deed, appoints their own trustees and nominates their preferred beneficiaries.

• The member may normally alter their trustees and preferred beneficiaries at a later date.

• The scheme administrator will pay any lump sum death benefit directly to the trustees appointed by the member.

• The trustees will distribute the lump sum in accordance with the terms of the trust.

Nomination - Advantages

• Simple process

• Payment may be made directly to beneficiaries by the scheme administrator without waiting for probate

• Payment will normally be free of IHT

Individual Trust - Advantages

• The member is able to appoint their own trustees (this may provide greater certainty that their wishes will be carried out)

• Payment may be made directly to the trustees by the scheme administrator without waiting for probate.

• Payment will normally be free of IHT.

Nomination - Disadvantages

• The nomination is not binding on the scheme administrator. Although they would consider the member’s nomination, payment to the nominated beneficiaries cannot be ‘guaranteed’.

• The nomination must be reviewed regularly to make sure it reflects any changes in the member’s personal circumstances.

• A retirement annuity or buyout plan generally has no discretionary powers written into the policy terms and conditions, although, there may be a limited opportunity for a member to select how benefits may be paid i.e. as an income to a dependant instead of a lump sum. This means a nomination option will not be available and any lump sum death benefits will usually be payable to the member’s estate unless they place their policy under a suitable pension trust.

Individual Trust - Disadvantages

• Complex documentation (in comparison with a nomination).

• Bringing a trust to an end is complex and may not be possible. The client will need to refer to their legal advisers if they wish to do this.

• New trustees will need to be appointed if existing trustees die or retire from their role as trustee.

• Depending on the terms of the trust, trustees are likely make payment to the member’s preferred beneficiaries, although this is not ‘guaranteed’.

• A member may not have the option to place their policy under a separate trust e.g. if their plan is held in an occupational pension scheme. In these circumstances the member will usually be able to make a nomination instead.

Additional points to consider

• There may be other options or restrictions contained in your client’s scheme rules and policy terms and conditions.
• Clients with stand alone pension contracts e.g. a buy-out plan, a retirement annuity contract or some individual policies assigned to the member following wind-up of an occupational pension scheme, may not have the option to nominate a beneficiary.

If nomination is not an option, the member may still have the opportunity to place their plan under an appropriate separate trust.

• If your client’s pension plan is part of an occupational pension scheme, they may not be able to place their plan under a separate trust. However, they will usually be able to nominate their preferred beneficiaries.
• The requirements of different schemes will vary. Usually the scheme administrator will need to be notified of any nominations or revised nominations by the member in writing before their death – this means any nominations held on file by an employer or adviser and passed to the scheme after the member’s death will not be valid.
• When nominating a trust as a potential beneficiary of a lump sum death benefit, the member will usually need to name the trustees.
  

  For example, ‘ name of trustee and name of trustee, as trustees of the XYZ trust, dated xx/xx/xxxx ’.

  They will usually need to update their nomination if the trustees of that trust change.

• The amount of detail requested for a nomination may also vary between schemes – as much information as possible needs to be supplied in the nomination to assist the scheme administrator identify and trace the nominated beneficiary at a later date. Any missing or unclear information may mean the member’s wishes cannot be considered, causing further distress for the member’s family at a difficult time.

• Guidance on inheritance tax issues is contained in the Inheritance Tax Manual available on the HMRC website.

Next steps

• It is important to identify the options which are available to your client under their existing pension arrangement.
• Are your clients able to make a nomination or do they need to consider placing their plan under a separate trust?
• Is your client in good health? Do they have any dependants or specific wishes regarding distribution of their pension fund following their death?
• Have your clients’ personal circumstances changed since they started their plan, or last reviewed their nomination – do they need to review and update their existing nomination?

Important information

This article provides an overview of the options which may be available to your client. The choice offered by different pension schemes will vary, as will the extent of discretion scheme trustees or administrators are able to exercise. You and your clients are strongly advised to consider the tax, legal consequences and risk attached to any decisions made. Your attention is specifically drawn to the taxation and legal structure of discretionary trusts. It is recommended that appropriate tax and/or legal advice is sought to ensure that any arrangements made are suitable for your client’s personal circumstances.

This information has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2021. It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice. Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients. You should always seek appropriate legal or other professional advice.(Ref 3.3)