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For financial advisers - compiled by our team of experts, qualified in pensions, taxation, trusts and wealth transfer.

Death benefits under primary and enhanced protection

3 April 2019

Key points

  • Primary and enhanced protection were available to people who had accrued significant pre A-Day benefits to give some protection against potential lifetime allowance tax charges
  • On death, certain types of death benefit are tested against the deceased’s lifetime allowance
  • The existing protections can help to mitigate a lifetime allowance charge but special rules might mean an increase to their protected lifetime allowance for those with certain lump sum death benefits

Jump to the following sections of this guide:

Transitional protection

When the lifetime allowance (LTA) was introduced at A-Day (6 April 2006), there were two types of protection brought in at the same time. The aim was to give individuals who were close to, or already over the initial £1.5M LTA a measure of protection from the LTA tax charge on any unvested benefits.

The two protections were:

  • Primary protection - This was only available for those who had pension benefits greater than £1.5M as at 5 April 2006. This included the value of any pensions that were already in payment at that date.

    The protection was given as an enhancement to the standard LTA based on how much the individual’s benefits exceeded £1.5M.
  • Enhanced protection - Anyone could apply for this as long as no further contributions were paid to money purchase (DC) pension schemes.

    The protection for money purchase schemes was a complete exemption from the LTA charge regardless of how much the pension funds grew.

    For defined benefit schemes, contributions and membership didn’t have to stop to qualify for enhanced protection, but there was a limit on the amount of benefits that the scheme could pay out (or transfer to another pension scheme). This is known as the ‘appropriate limit’ and is calculated by revaluing the accrued benefits at A-Day by the greater of various allowable factors.

    Enhanced protection could be lost by paying a pension contribution to a money purchase scheme or a defined benefit scheme paying or transferring benefits over the appropriate limit.
Note - see the individual technical guides on primary and enhanced protection for further information on how they work and how the protection could be lost.

The possible lifetime allowance tests on death

When the member vests any of their benefits (known as a benefit crystallisation event, or BCE), they’re tested against the LTA. Any protection they have at the time of a BCE can prevent or reduce a LTA tax charge.

On the member’s death, the payment of certain death benefits are also tested against the deceased’s LTA and their protection can still help in these instances.

The following benefits are tested against the LTA on the death of the original member before age 75:

Defined benefit schemes

  • Lump sums - known as defined benefit lump sum death benefits. These are paid by the scheme following the death of the member. Typically these are death in service benefits, usually based on a multiple of salary.

Money purchase schemes

  • Lump sums from uncrystallised funds (including lump sums from life cover).
  • Designating uncrystallised funds for survivor’s income drawdown.
  • Purchasing a survivor’s lifetime annuity from uncrystallised funds.

Two year rule

All of these types of death benefit are only BCEs if they are paid (or designated/purchased) within two years of the date the pension scheme administrator first knew, or could reasonably have been expected to know of the member’s death (whichever is earlier). If there isn’t enough of the deceased’s LTA, the recipients will have to pay a LTA charge, but there would be no other income tax liability.

If they’re paid outside of the two year period, they’re no longer tested against the LTA but they will be subject to income tax at the recipient’s marginal rate (or a flat rate of 45% if not being paid to an individual, for example, going to a trust).

Death benefits not tested against the LTA

A dependant’s pension paid from a defined benefit scheme is typically classed as a scheme pension and not tested against the LTA. Defined contribution schemes can also provide scheme pensions for dependants but this less common. A dependant’s scheme pension is subject to income tax at the recipient’s marginal rate. 

Primary protection and death benefits

The increase to the LTA given by primary protection was based on the benefits the individual had accrued as at 5 April 2006, including pensions already in payment. However, it was only retirement benefits that were taken into account - the rights to life assurance cover or other lump sum benefits that only had a value on death couldn’t be included.

But, a recalculation of primary protection to cover lump sum rights is possible in some circumstances.

Pension death benefits

On death, the payment of a survivor’s pension from a money purchase fund, whether paid as income drawdown or lifetime annuity income is a BCE.  

Dependants’ pensions from DB schemes as well as dependants’ scheme pensions under a money purchase arrangement are not BCEs.

A recalculation of the individual’s primary protected LTA isn’t possible when death benefits (survivor’s pension or lump sum) are only paid from a money purchase fund. This is because the money purchase fund was taken into account at A-Day when calculating the primary protection enhancement factor. Unfortunately this doesn’t rule out a LTA tax charge on death, as the fund growth and additional contributions could mean that the fund value on death exceeds the individual’s primary protected LTA.

Lump sum death benefits

Initially, BCEs from lump sum death benefits are tested against the deceased’s remaining LTA increased by the original primary protection factor. However, because some types of lump sum death benefit wouldn’t have been included in the original primary protection factor, it is possible to recalculate in some circumstances.

There are two types of lump sum death benefit - a defined benefits lump sum death benefit (for example, a 4 x salary death in service lump sum) and an uncrystallised funds lump sum death benefit from a money purchase scheme (which could be the return of fund from a scheme, or insured life cover).

Benefits that are only payable on death only, such as the death in service or life cover lump sum, wouldn’t have been included when working out the primary protection factor. If this type of death benefit is payable, it may be possible for the recipient of the lump sum death benefits to ask HMRC to recalculate the deceased's enhancement factor based on the lump sum death benefit cover in force on 5 April 2006. This can give a bigger personal LTA on death if, as at 5 April 2006, the lump sum death benefits were worth more than the individual's retirement benefits.

The recalculation is based on the amount of lump sum death benefits only that could have been paid had the deceased died back on 5 April 2006. In order for it to apply, this total would need to:

  1. be greater than £1.5M, and
  2. be greater than the retirement benefits used to calculate the original primary protection amount.

Exclusions when calculating lump sum death benefits as at 5 April 2006

The following are excluded:

  • Any amount above the maximum HMRC limits for death benefits under the rules in force on 5 April 2006.
  • The dependants' pension proportion amount (if any). This is broadly any proportion of the lump sum paid on death that is used to provide dependants' pensions. However, pensions payable to non-dependants (nominees and successors) don’t affect the calculation.
Example

On 5 April 2006, Phil was a member of an occupational scheme providing a lump sum death benefit of 4 times his pensionable salary. His pensionable salary on 5 April 2006 was £75,000, giving him life cover of £300,000.

By the time of his death on 10 January 2019, Phil's pensionable salary had increased to £120,000 giving him life cover of £480,000. The scheme uses £160,000 of the life cover (33.33%) to buy a pension for his widow. So the dependant's pension proportion is calculated as 33.33% (£160,000/ £480,000).

So, when recalculating Phil's primary protection factor on death, the value of the lump sum death benefits will be 66.67% of the life cover in place on 5 April 2006. This gives £200,000 for the life cover as at 5 April 2006 (that is, £300,000 x 66.67%).
  • Any lump sum death benefit payable under a life assurance policy on 5 April 2006 by any scheme (other than an occupational pension scheme with at least 20 members on 5 April 2006) where:

    • the policy doesn't pay out a lump sum after 5 April 2006, or
    • the terms of the policy are changed significantly in the period between 5 April 2006 and the date of death.
  • Any lump sum death benefit payable from an occupational pension scheme on 5 April 2006 where:

    • the individual wasn't continuously employed in the period from 5 April 2006 to the date of death by either the same employer as they had been on 5 April 2006 or by someone connected with that employer, or
    • the individual was already entitled to benefits under the occupational pension scheme before their death.

These items are also excluded when recalculating the appropriate limit under enhanced protection.

Example

T
aking death benefits as a lump sum

Harbindar registered his money purchase pension rights worth £1.8M for primary protection. This gave him a primary protection factor of 0.2 - that is, a personal LTA of 120% of the standard LTA. In addition to his £1.8M fund, on 5 April 2006 he was also covered for a lump sum death benefit of four times his pensionable salary, amounting to cover of £300,000 meaning the total value of his death benefits were £2.1M.

In March 2019, he died with a pension fund valued at £2.5M and a lump sum death benefit of £420,000. His widow, Hannah, requested that the amount of primary protection he had was recalculated to take account of the total lump sum death benefits that could have been paid on the 5 April 2006.

All the criteria were met:

  • Benefits at 5 April 2006 were within HMRC limits.
  • None of the lump sum on actual death is being used to pay a pension.
  • The death in service arrangement hadn't been varied.
  • Harbindar stayed in employment with the company that provided the lump sum death benefits on 5 April 2006.
Harbindar's primary protection factor was recalculated as 0.4 - i.e. (£2.1M - £1.5M) /£1.5M.

So, a lump sum death benefit of up to £2.52M (1.4 x £1.8M) could be paid to Hannah without a LTA tax charge. Funds in excess of this amount would be subject to a 55% LTA tax charge, i.e. £2.92M less £2.52M x 55% = £220,000.

Taking death benefits from his money purchase pension as inherited drawdown

The ability to opt for a recalculation of the primary protection factor may have little or no benefit if the recipient of the death benefit is a dependant and they choose inherited drawdown (or some other form of dependant’s income) This is because the value of the death benefits used to provide income for a dependant will be excluded when calculating the value of death benefits at 5 April 2006.

For example, if Hannah designated the £2.5M money purchase fund for dependant’s drawdown, the excluded dependants portion would be:

£2.5M (Hannah’s drawdown fund) / £2.92M (Total value of death benefits) = 85.62%

So, when recalculating Harbindar’s primary protection factor based on death benefits, the value will be just 14.38% of the lump sum death benefits that could have been paid on 5 April 2006, i.e. £2.1M x 14.38% = £301,980. As this is less than £1.5M, there would be no improvement to the primary protection factor on recalculation and the original enhancement factor of 0.2 would apply, giving a protected LTA of £2.16M. 

Enhanced protection and death benefits

The way enhanced protection covers death benefits differs between money purchase and defined benefit schemes.

Money purchase schemes

As long as enhanced protection is still in force at the date of death then benefits from money purchase schemes, whether paid as lump sums or in the form of a pension are fully covered.

Enhanced protection remains in force as long as no contributions are paid to a money purchase scheme after 5 April 2006. However, there are special rules concerning ongoing life cover under money purchase schemes (typically as term assurance under personal pensions and retirement annuity contracts).

Maintaining payments to life assurance contracts

Enhanced protection will not be broken by continuing contributions if:

  • they're used to fund life cover under a contract of insurance,
  • the insurance contract was made before 6 April 2006*,
  • there's no right to surrender any rights under the policy,
  • there's no payment under the policy except on the individual's death, and
  • the policy isn't varied significantly. Examples of significant variation are:

    • extending the contract term
    • an increase in the contributions or amount of death benefit (although if the terms of the policy provide for automatic increases, that wouldn't be a variation)
    • the addition or removal of an extra benefit
    • taking a contribution holiday

* A new policy can be treated as a pre 6 April 2006 contract if it’s surrendered and replaced by a new one to comply with:

  • the Employment Equality (Age) Regulations, or
  • Section 255 of the Pensions Act 2004 (which prohibits 'life assurance only' categories under occupational pension schemes where there's no intention to ever provide pension benefits for the members in the life assurance only category).

Defined benefit schemes

Pension death benefits from DB schemes can only be paid in the form of scheme pensions to dependants and are not tested against the LTA.

Defined benefit lump sum death benefits are tested against the deceased’s LTA and for enhanced protection this means the amount needs to be within the appropriate limit otherwise protection will be lost. In that event, the lump sum would be then tested against any remaining amount of the standard LTA (or potentially any personal LTA granted through primary or individual protection if either applies).

The appropriate limit

The appropriate limit is usually calculated based on the value of the individual's retirement benefits under the DB scheme on 5 April 2006. These are then revalued up to the point of retirement, transfer, or death by the higher of RPI or 5% per annum, or if the member remains in service with the employer, they can also use their increased pensionable salary (subject to certain rules – see the enhanced protection guide for full details).

But on death, special rules allow the recipient of any lump sum death benefit to ask HMRC to recalculate the appropriate limit based on the value of the lump sum death benefits that would have been payable on 5 April 2006, if this is greater than the normal appropriate limit.

Exclusions when calculating lump sum death benefits as at 5 April 2006

Here we use the same exclusions that apply to primary protection, which are:

  • Any amount above the maximum HMRC limits for death benefits under the rules in force on 5 April 2006.
  • The dependants' pension proportion amount (if any). This is broadly any proportion of the lump sum paid on death that is used to provide dependants' pensions. However, pensions payable to non-dependants (nominees and successors) don’t affect the calculation
  • Any lump sum death benefit payable under a life assurance policy on 5 April 2006 by any scheme (other than an occupational pension scheme with at least 20 members on 5 April 2006) where:

    • the policy doesn't pay out a lump sum after 5 April 2006, or
    • the terms of the policy are changed significantly in the period between 5 April 2006 and the date of death.
  • Any lump sum death benefit payable from an occupational pension scheme on 5 April 2006 where:

    • the individual wasn't continuously employed in the period from 5 April 2006 to the date of death by either the same employer as they had been on 5 April 2006 or by someone connected with that employer, or
    • the individual was already entitled to benefits under the occupational pension scheme before their death.
Example

At 5 April 2006, David had a paid up retirement annuity contract worth £1.2M and was a member of a defined benefit pension scheme where he had accrued 10/60ths of a final salary of £90,000. The notional capital value of the final salary scheme at 5 April 2006 would be £300,000 [that is, 20 x (10/60 x £90,000)], so his total benefits were valued at £1.5M. His DB scheme also provided 4 x salary death in service benefits. David registered for enhanced protection and remained a member of the defined benefit pension scheme.

He died on 10 April 2018. His retirement annuity contract had increased to £2M. The rules of the scheme allowed the whole fund to be paid out on death. The payment of the lump sum is a crystallisation event so £2M is tested against the standard LTA in 2018/19 of £1.03M but as David’s enhanced protection is still in force, there is no LTA charge on the excess above the £1.03M.

The rules of the defined benefit pension scheme allowed a lump sum of 4 x salary to be paid out. David's salary was £138,000 when he died, so the scheme could pay out £552,000 as a lump sum. But because this is from a defined benefit scheme, this has to be within the appropriate limit to maintain the enhanced protection.

If the appropriate limit was worked out in the normal way, it would be the value of the pension benefits at 5 April 2006 (£300,000) increased in line by the greater of RPI and 5%, or calculated using David's earnings at the date of death. In this case, 5% revaluation produces the highest figure, coming to £538,756. So, if the defined benefit pension scheme paid out a lump sum of £552,000, this would be more than the appropriate limit and enhanced protection would be lost.

If that was the case, the death in service lump sum would go back to being tested against the standard LTA - but the lump sum from the retirement annuity contract has already used all of that up, which would mean the £552,000 from the death in service would all be subject to the 55% LTA tax charge.

However, the recipient of the lump sum could ask HMRC to apply the alternative appropriate limit allowed on death. The lump sum that could have been paid had David died on 5 April 2006 would have been £360,000 (4 x £90,000). This is allowed because David met the rules set out above.

The £360,000 can be revalued also by 5% to give a figure of £646,508. This means that the actual lump sum death benefit of £552,000 from the final salary scheme is well within this recalculated appropriate limit and enhanced protection is maintained.

David’s widow was also entitled to a 50% dependant’s pension, but this is not tested against the LTA.The recalculated appropriate limit figure can then be increased up to the date of death in the usual way.

Maintaining death in service benefits under enhanced protection

To qualify for enhanced protection, contributions to DB schemes didn’t have to cease as maintaining the protection is based on the appropriate limit. This enables ongoing membership of a death in service arrangement to continue.

However, enhanced protection is lost if the individual becomes a member of a new arrangement other than in the following permitted circumstances:

  • to accept a permitted transfer of pension rights,
  • to comply with the Employment Equality (Age) Regulations, or
  • to comply with Section 255 of the Pensions Act 2004 (which prohibits 'life assurance only' categories under occupational pension schemes where there's no intention to ever provide pension benefits for the members in the life assurance only category).

In relation to death in service benefits, if an individual becomes a member of a new arrangement after 5 April 2006 that don’t meet the above criteria, for example on joining a new employer, then they would lose their enhanced protection.

Applying for a recalculation of protection

The recipient of a lump sum death benefit can ask HMRC to recalculate the primary protection factor or the appropriate limit for enhance protection if that will give a greater amount of protection.

The notification must be made to HMRC within five years following 31 January after the tax year in which a defined benefits or uncrystallised funds lump sum death benefit was paid.

There isn't a specific HMRC form to be completed; a letter signed by the applicant containing all of the following information is needed:

  • the name and address of the person making the notification
  • the name of the deceased protected member
  • the name of the pension scheme under which entitlement to payment of the defined benefits lump sum death benefit or uncrystallised funds lump sum death benefit arose
  • the name and address of the scheme administrator making the payment
  • the amount of the defined benefits lump sum death benefit or uncrystallised funds lump sum death benefit received by the person making the notification
  • the date on which the payment was made
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