Elaine Turtle: Quirky scheme pension death benefit rules explained

Elaine Turtle looks at what happens when a scheme pension member dies and how to safely navigate the arrangement’s quirks

A scheme pension is the only way a defined benefits arrangement may provide its members with a pension benefit. It is also possible for a money purchase arrangement to provide a scheme pension.

Scheme pension SIPPs became increasingly popular when the GAD rate dropped, and it meant for a lot of pensions that were being paid under capped drawdown or alternative secured income (ASP) they were reduced at their review.

Also at the same time, to add into the equation was the fact that if a member died after the age of 75 there was a tax liability of up to 82%.

Due to these factors, a number of clients transferred over to scheme pension where the actuary sets the pension based on the health of the member, their fund size and the return on the fund.

Quirky by nature

It is understandable that not many clients understand the quirks of scheme pension as it is quite complex.  When the government brought in flexi access drawdown (FAD) anyone already in scheme pension was not able to convert to FAD, this was due to it being considered a ‘guaranteed’ pension.

Another quirk is that each scheme pension must be reviewed every three years but a member or their adviser can request a review at any time.

There was a case recently where the pension scheme member Brian McDonald died at age 82, his wife had predeceased him some years ago and the fund was left to his two sons.

When Brian died, his adviser Tim, contacted us to tell us he had passed away and asked what the process on death was and what would happen to the funds. We explained that we would need a certified copy of the death certificate and Brian’s will and once we had these, we would check this with our Expression of Wish which we held on file. I then went on to explain to the adviser that scheme pension is different from how a normal SIPP would payout when there has been a death – for two main reasons:

  • Firstly there is no two-year time limit to paying out pensions
  • Secondly, there is a ‘cap’ to the lump sum payment

Initially, we have to check if there is any guarantee period left on the pension being paid – most Scheme pensions are set up with a 10-year guarantee. This means that the pension being paid must continue until the end of the guaranteed period, and this amount can only be paid each year and only at the end of the guarantee period if funds are left, they can be paid out as a lump sum.

Fortunately, Brian’s guarantee period had finished. The second quirk of scheme pension on the ‘cap’ of the amount of lump sum payment, is that the lump sum to be paid out can be no more than 20 times the original pension set by the actuary less the pensions paid over the period the member has been receiving a pension.

So we looked into Brian’s scheme.  His fund was currently around £82,000 and his original pension was £9,800 per annum.  20 x £9800 = £196,000, less total pensions paid – £60,800 = £135,200 so that is the maximum we can pay out. As we only have £82,000 left then we are ok to make the payment.

The tax on the payment is the same as other deaths after age 75, both sons wanted the lump sum so Tim disinvested the funds and the cash arrived in the pension scheme bank account. We paid both sons out at the end of that month less their marginal tax and the scheme was wound up.

As most people in scheme pension through SIPPs are getting older and no one would now go into the arrangement due to the advantages of FAD this is getting a smaller and smaller group.

Elaine Turtle is director at DP Pensions