Only 7% of UK adults who have a personal pension can correctly identify how their pension funds will be treated on their death and only 4% can correctly identify how they would be taxed, according to new research from AJ Bell*. Nine million people** contribute to personal pensions in the UK, suggesting that around 8.4 million UK consumers don’t understand the death benefit rules introduced as part of the pension freedoms.
The platform and pension provider has written to Philip Hammond, Chancellor of the Exchequer, calling for the discretion providers currently have around how pension death benefits are distributed to be removed, with all pension death benefits remaining free of inheritance tax.
Andy Bell, chief executive at AJ Bell, comments:
“The way pension death benefits are taxed is one of the most generous outcomes of the pension freedoms but this is lost on the vast majority of people. Most of them also assume the funds will automatically go to their nominated beneficiary, without realising that their pension provider currently has discretion to alter that. In the new era of pension freedoms this control should remain with the pension holder, not the pension provider.”
The research
985 UK adults who have a personal pension were asked whether they know what will happen to their pension fund upon their death. The research showed that only 7% can correctly identify that their pension provider will decide who it goes to, taking into account their nominated beneficiaries.
Half (51%) assume it will automatically go to the person they have nominated as the beneficiary of their pension. 14% think it will form part of their estate and be distributed as per their will, and a quarter (25%) admitted they don’t know.
When it comes to how their pension will be taxed upon their death, only 4% of people questioned correctly identified that it would be tax free if they die before age 75 and subject to income tax of the beneficiary if I they die post 75. A majority (58%) admitted outright that they don’t know while some others thought it would be subject to the main forms of taxation such as income tax (10%) or inheritance tax (14%). 11% thought it would be tax free.
Additionally, only one in five British adults with personal pensions (18%) have nominated who they would like to receive their pension on death within the last three years. A third (32%) have never nominated a beneficiary and another third (35%) nominated their beneficiary over five years ago.
Family circumstances change regularly – there are around two million life events that could affect these nominations such as births, deaths, marriages and divorces every year in the UK – and so the majority of these nominations are likely to be out of date. (Full details of the research below).
How pension death benefits are taxed
Pension death benefits are exempt from IHT in most cases because the pension provider has discretion around who they are paid to. Additionally, the Inheritance Tax Act 1984 explicitly exempts contributions and undrawn funds that remain in a pension scheme.
Exceptions to this apply. For example, where the pension provider does not have discretion, IHT is due. There is also an anomaly in the rules where IHT can be applied if someone makes a pension transfer while knowingly having a terminal illness and dies within two years of the transfer.
This means some providers withhold 40% of death benefits until the estate has been settled on cases that have been transferred to them within two years of death for fear of HMRC taxing them (legislation allows HMRC to pursue the provider of the pension scheme for IHT).
Given the lack of understanding on the most basic points evidenced by the research, it is clear that people will not expect their pension to be subject to IHT if they transfer it when they know they are seriously ill. They will assume that because they are transferring from one IHT free vehicle to another there is no IHT liability.
The problem
The fact that pension providers have discretion over who death benefits are paid to, can give people an IHT benefit. However, most people don’t understand the process and hence they don’t know who will receive their pension death benefits or how they will be taxed. Pension providers are obliged to consider all potential beneficiaries but family circumstances change frequently and people don’t update their nominated beneficiaries regularly.
This causes disputes and delays at an already difficult time for the families involved and it results in unnecessary administrative and legal expenses.
AJ Bell proposal
AJ Bell is calling on the Treasury to provide a blanket IHT exemption on pension death benefits regardless of who they are paid to. This would enable provider discretion to be removed from pension death benefits and bring a degree of simplification to an area that is clearly not well understood by consumers.
All pension providers could then adopt a standard way of paying death benefits to the people nominated by the pension holder in the first instance or to the people identified by the executor of the pension holder’s estate if the nominated beneficiaries cannot be found.
The result would be a simpler system that people have a better chance of understanding and would be aligned with the pension freedoms which give people greater choice and control over how their pension savings are used.
Andy Bell, continues:
“A relatively straightforward change to the rules could greatly simplify this area of the pension system without being a huge cost to the Government. It is clear that the current rules are designed so that pensions are not liable to inheritance tax in the vast majority of cases and so formalising that outcome in all cases is not a difficult step for the Government to take. It is an oddity that the provider having discretion over the payments is a condition of this tax treatment and feels out of place in today’s world of pension freedom and choice.
“Removing provider discretion over pension death benefits and ensuring they all remain free of inheritance tax would give pension savers greater control over who receives their hard earned pension savings when they die and would make the rules significantly easier for people to understand and hence place a value on.”
AJ Bell research findings:
What will happen to your pension fund in the event of your death?
It will automatically go to the Government
| 4% |
It will form part of my estate and be distributed as per my will
| 14% |
It will go automatically to the person I have nominated as the beneficiary of my pension
| 51% |
My pension provider will decide who it goes to, taking my nominated beneficiaries into account | 7% |
I don’t know what will happen to my pension upon my death | 25% |
Base: All UK adults with a personal pension (n=985)
How do you think your pension fund will be taxed in the event of your death?
It will be subject to inheritance tax
| 10% |
It will be subject to capital gains tax
| 2% |
It will be tax free
| 11% |
It will be subject to income tax of the beneficiary
| 14% |
It will be tax free if I am under 75 and subject to income tax of the beneficiary if I am over 75 | 4% |
Don’t know | 58% |
Base: All UK adults with a personal pension (n=985)
Have you nominated who you would like to receive your pension in the event of your death?
Yes, within the last year | 8% |
Yes, within the last 2 years | 5% |
Yes, within the last 3 years | 5% |
Yes, within the last 5 years | 9% |
Yes, but more than 5 years ago | 35% |
No | 32% |
Don’t know | 6% |
Base: All UK adults with a personal pension (n=985)
Methodology note
*ComRes interviewed 985 UK adults with a personal pension online between the 26th and 27th of July 2017. ComRes is a member of the British Polling Council and abides by its rules. Full data tables are available on the ComRes website, www.comresglobal.com.
**Source: HMRC personal pension statistics, 29th September 2017. 93% of 9 million = 8.4 million.