EIM75620 - The taxation of pension income: lump sums paid by registered pension schemes following a member's death

Overview
Lump sums paid on death in service
Lump sums on the death of a member receiving a scheme pension or lifetime annuity
Death of a member receiving drawdown pension
Trivial commutation lump sum death benefit
Winding-up lump sum death benefit
A qualifying person and a non-qualifying person
The relevant two-year period
Lump sums and PAYE
The special lump sum death benefits charge

Overview

Registered pension schemes may pay lump sums following the death of a member. This may be following the death of a member before they start their pension or after they start their pension. The type of lump sum paid and its tax treatment depends on a number of factors, such as if the member had started to take a pension and the type of pension in payment.

Some lump sums may be paid tax-free, some are subject to specific tax charges, and some are taxable as pension income.

Lump sums paid on death in service

Sections 637H and 637J ITEPA 2003
Sections 206(1A) and 216 (BCE 7) Finance Act 2004
Section 19 Finance (No 2) Act 2023

The types of lump sum that may be paid in respect of pension funds that have not yet been ‘put into payment’ are:

  • defined benefits lump sum death benefit
  • uncrystallised funds lump sum death benefit

Lump sums are not taxed as pension income if paid in respect of a member who was aged under 75 when they died, and the lump sum was paid within the relevant 2-year period, and the member has remaining lump sum and death benefit allowance. The amount exceeding the member's available lump sum and death benefit allowance is taxed at the recipient's marginal rate as pension income. 

Lump sums paid to a qualifying person after 5 April 2016 are taxable as pension income of the recipient where the lump sum is either:

  • paid in respect of a member who was 75 or older when they died
  • not paid within the relevant two-year period.

Lump sums paid to a non-qualifying person after 5 April 2016 are subject to the special lump sum death benefits charge where the lump sum is either:

Lump sums paid before 6 April 2016 cannot be taxed as pension income.

PTM073100 provides detailed guidance on the conditions for paying a defined benefits lump sum death benefit and the tax treatment of payments made before 6 April 2016.

PTM073200 provides detailed guidance on the conditions for paying an uncrystallised funds lump sum death benefit and the tax treatment of payments made before 6 April 2016.

Lump sums on the death of a member receiving a scheme pension or lifetime annuity

Sections 637I and 637K ITEPA 2003
Section 206(1) Finance Act 2004

When a member receiving a scheme pension or lifetime annuity dies, the registered pension scheme may pay:

  • a pension protection lump sum death benefit
  • an annuity protection lump sum death benefit.

Lump sums paid after 5 April 2016 are not taxable where they are paid in respect of a member who was aged under 75 when they died.

Lump sums paid to a qualifying person after 5 April 2016 are taxable as pension income of the recipient where the lump sum is paid in respect of a member who was 75 or older when they died.

Lump sums paid to a non-qualifying person after 5 April 2016 are subject to the special lump sum death benefits charge where the lump sum is paid in respect of a member who was 75 or older when they died.

Lump sums paid before 6 April 2016 cannot be taxed as pension income.

PTM073300 provides detailed guidance on the conditions for paying a pension protection lump sum death benefit and the tax treatment of payments made before 6 April 2016.

PTM073400 provides detailed guidance on the conditions for paying an annuity protection lump sum death benefit and the tax treatment of payments made before 6 April 2016.

Death of a member receiving drawdown pension

Section 637L and 637M ITEPA 2003
Sections 206(1), (1ZA), (1B) and (1C) Finance Act 2004

When a member receiving a drawdown pension dies, part or all of the remainder of their drawdown funds may be used to pay a:

  • drawdown pension fund lump sum death benefit
  • flexi-access drawdown fund lump sum death benefit.

These lump sums can be paid when a member or beneficiary dependant who was receiving drawdown pension dies.

Lump sums paid after 5 April 2016 are not taxable if the member or beneficiary in respect of whom the lump sum was paid was aged under 75 when they died and the lump sum was paid within the relevant two-year period. 

Lump sums paid to a qualifying person after 5 April 2016 are taxable as pension income of the recipient where either: 

  • the member or beneficiary in respect of whom the lump sum was paid was 75 or older when they died
  • the lump sum was not paid within the relevant two-year period.

Lump sums paid to a non-qualifying person after 5 April 2016 are subject to the special lump sum death benefits charge where either:

  • the member or beneficiary in respect of whom the lump sum was paid was 75 or older when they died
  • the lump sum was not paid within the relevant two-year period

Payments made before 6 April 2016 cannot be taxed as pension income.

PTM073500 provides detailed guidance on the conditions for paying a drawdown pension fund lump sum death benefit and the tax treatment of payments made before 6 April 2016.

PTM073600 provides detailed guidance on the conditions for paying a flexi-access drawdown fund lump sum death benefit and the tax treatment of payments made before 6 April 2016.

Trivial commutation lump sum death benefit

Section 637N ITEPA 2003

This is a lump sum payment payable to a dependant or the recipient of a pension guarantee payment. Where the pension is below a certain amount, they can choose to commute that pension into a lump payment. PTM073700 provides guidance on the payment conditions for this type of lump sum.

The lump sum is taxable as pension income of the dependant.

A qualifying person and a non-qualifying person

Section 206(9) Finance Act 2004

A non-qualifying person is someone who is not an individual, for example, a company, or an individual receiving the lump sum in their capacity as a:

  • trustee (other than a bare trustee)
  • personal representative
  • director of a company
  • partner in a firm
  • member of a limited liability partnership.

A qualifying person is someone who is not a non-qualifying person. So, broadly, a qualifying person is an individual who is receiving the lump sum payment in their own right.

The relevant two-year period

This is the period of 2 years from the earlier of:

  • the day the scheme administrator first knew of the member’s (or beneficiary’s) death
  • the day on which the scheme administrator could first reasonably have been expected to have known of the member’s (or beneficiary’s) death.

Lump sums and PAYE

Section 683 ITEPA 2003

Where the lump sum is taxable as pension income the payer should deduct tax under PAYE. The amount of tax to be deducted and the PAYE code to be used depends on the type of lump sum. Further guidance on the operation of PAYE can be found in CWG2: further guide to PAYE and National Insurance contributions.

The special lump sum death benefits charge

Section 206 Finance Act 2004

Certain lump sum payments are subject to this tax charge. The person liable to pay the tax charge is the registered pension scheme administrator. Often schemes will deduct the tax due before paying the lump sum. The rate of the tax charge is 45% since 6 April 2015.

If the recipient of the lump sum is a non-taxpayer or pays tax at a rate less than the rate of the special lump sum death benefits charge, they cannot reclaim the tax. This is because it is not the recipient who is liable to pay the tax; it is the responsibility of the scheme administrator to report and pay the tax to HMRC.