I don’t think that many would disagree that the 2015 “pension freedom” changes radically altered the landscape for defined contribution pension arrangements.
For financial advisers, it was the changes to the death benefit tax rules applying to money purchase arrangements, that were amongst the most significant. In addition to the greater flexibility on retirement planning the new rules brought, the ability to cascade pension wealth in a tax-efficient manner meant that these arrangements became a key component and consideration for succession planning.
Fundamental to the new tax rules for death benefits was the introduction of beneficiary flexi-access drawdown (or BFAD for short). This has given individuals the ability to pass on pension benefits in a manner where beneficiaries have immediate access to pension funds after death, but the funds still retain some of the main advantages of being within a pension arrangement (such as tax-free growth and favourable IHT treatment). Receiving benefits as BFAD can also reduce any potential lifetime allowance charges; and where the member dies over age 75, it also allows the beneficiaries some control over the amount of any income tax payable.
However, the rules for who can receive pension funds as a BFAD arrangement, are quite complex and sometimes lead to some confusion.
Where death benefits are to be settled on a discretionary basis, the benefits themselves, can be paid to anyone within the class of potential beneficiaries as per the scheme rules. It is also true to say that anyone within that class of potential beneficiaries can be paid a lump sum. However, it doesn’t necessarily follow that those same beneficiaries will always have the option to receive those pension death benefits as a BFAD arrangement.
The first and more simple consideration is whether the member’s pension scheme actually offers the ability for beneficiaries to receive benefits as BFAD. Legislation for offering BFAD is “permissive” rather than “prescriptive” – meaning that there is no compulsion for pension providers to offer this option.
The second point (and this is where the confusion sometimes come in), is that while the term “Beneficiary Drawdown” is widely used, this is actually broken down into 3 different types of BFAD, which are Dependants Drawdown, Nominees Drawdown and Successors Drawdown. As such, even where a pension arrangement, such as our pension, offers beneficiary drawdown as an option on death, the provider can only offer that option to the receiving beneficiary if they are deemed as a “dependant”, a “nominee” or a “successor” under pension legislation. So, I will look at these in turn.
The definition of a dependant is written within the 2004 Finance Act, but in broad terms it will include any spouse or civil partner on the date the pension member died, any children under 23, or any children aged 23 or over who were dependant for other reasons, such as being dependant as a result of a physical or mental impairment. Additionally, anyone who is not a spouse, civil partner or child but who was dependant on the member for financial reasons, or due to physical or mental impairment, may also be classified as a dependant.
If the beneficiary is classified as a dependant of the member and the scheme offers it, then BFAD will be an option to the beneficiary, regardless of whether they were, or they were not named in the expression of wishes.
As previously mentioned, If the beneficiary is not a dependant, then they could still receive benefits through a BFAD arrangement if they are a nominee of the member. In short, a nominee is any individual named by the pension member who is not a dependant. The scheme administrator can also potentially name a nominee, although they are only permitted to do so where there is no surviving dependant, or no other individual or charity has been nominated by the member. Therefore, in reality, it is usually very unlikely that the scheme administrator will be able to name any nominees, especially where an expression of wish form has been completed by the member. As such, non-dependants will generally need to be nominated by the member, if they are to be eligible for BFAD.
Finally, on the death of the dependant or nominee, benefits held in a BFAD arrangement can be offered to successors as successors drawdown if the beneficiaries of that arrangement had been nominated by the dependant or nominee. Again, scheme administrators can also name successors, but as with nominees, they are only able to do this if no other individual or charity has been named by the member. Again therefore, they are unlikely to be able to do this where an expression of wish form has been completed.
Successors with BFAD arrangements, can also nominate their own successors to receive their death benefits as BFAD and so on.
So, this brings me to the completion of expression of wish (EoW) forms.
Prior to the introduction of the new death benefit tax rules in April 2015, expression of wish documentation (EoW) fulfilled a single purpose. This was to give the pension scheme administrators, when exercising their discretion, an indication of how the pension member would like the benefits distributed.
Even after the changes, the most important information on expression of wish documentation remains the indication of how the member would like the benefits distributed in the event of their death. However, as a result of the greater flexibility in the tax rules, the beneficiaries named by the member are often different to who they may have been before the new legislation was introduced.
In addition, the option to “nominate” non-dependants so that benefits can be paid as BFAD has meant that advisers and their clients will need to consider what should happen if benefits, for whatever reason, are not paid to the named beneficiary. An example may be where the member wishes for their spouse to receive all the benefits but also has adult children. If the spouse could not receive the benefits (for example, if they died simultaneously), the member would like to ensure that BFAD is an option for the children, should they receive the benefits.
It is for this reason, that our expression of wish form has been split into two sections:
- The first section, titled “Beneficiaries” is for the member to name individual(s) who they would like to receive benefits and what percentage they would like to receive. Any individual named in this section would qualify for BFAD as an option.
- The second “Nominee” section is for the member to name or nominate any other individuals. So, if benefits were paid to these individuals, rather than being paid to the main beneficiary, they would also qualify for BFAD.
It is not unusual for a pension member’s wishes and needs to change frequently during their working life and into retirement. For example, if the member concludes they would like their pension benefits directed to their children rather than their spouse as part of their succession planning, it is important that the expression of wish form is updated to reflect this. I would say that the importance of regularly reviewing and updating expression of wish forms cannot be overstated.
I’ll conclude by reiterating the point that the legislation for beneficiary drawdown and the general rules for pension death benefits are very complex and can be quite confusing at times. To assist with your financial planning, we have produced a number of guides and aids, including a flow chart of when BFAD is available to beneficiaries. You will find these within the Technical matters section of our website.
In the meantime, thank you for watching and goodbye for now.