Summer Budget 2015: Changes to taxation of lump sum death benefits

The changes announced in the Budget affect lump sum payments made out of registered pension schemes or non-UK pension schemes following the death of the scheme member over the age of 75.

Since April 2015, lump sums paid out on the death of a scheme member have been exempt from tax if the scheme member is under 75 when he or she dies.  If the scheme member is older than 75 when they die, the lump sum payment is subject to tax at a flat rate of 45%.

From April 2016, any lump sum payment made after the death of an older scheme member to an individual will no longer be taxed at the 45% flat rate; instead, the lump sum will be taxed at the recipient’s own marginal rate of income tax. The tax will be collected under PAYE by the pension scheme administrator.

If the recipient is a trust or a company, the 45% rate will continue to apply.

This change should be good news for recipients of lump-sum death benefits, as it should mean that recipients on lower incomes have less tax to pay.  Unless the recipient is employed and has taxable employment income in excess of the additional rate threshold, less tax will be withheld by pension providers.

The recipients will need to consider the knock-on effect of the death benefit on their other income, as the lump sum, which will count as the first “slice” of their income, may push other income that is franked by tax credits or withholding taxes into higher rate tax bands, necessitating the completion of tax returns and payment of taxes.

The changes may, however, prove to be a headache for pension providers, who bear the obligation to withhold tax and will need to take steps to establish what rates and allowances to apply to each individual recipient.