Home > News > 2002 > September 2002 > Death benefits within a SIPP
Death benefits within a SIPP
SIPPs (or Self Invested Personal Pensions, to give the full name) have been growing in popularity in recent years as they allow individuals to take control of their own pension fund. Here, Claire Morley from our Cheltenham office explains what happens to these pension funds when the member dies.
Death Benefits is a subject which we'd perhaps rather not discuss, but most of us would like to think of our families and dependants being adequately provided for when the day comes.
A SIPP offers a means of building up a retirement fund and then drawing an income in retirement, without having to purchase an annuity until age 75. The benefits available on death vary depending on whether or not retirement benefits have started to be drawn from this SIPP.
Death before drawing retirement benefits
If you die before taking any retirement benefits, the whole of your SIPP fund can usually be paid as a cash sum, free of inheritance tax as the benefit will be paid at the Trustees' discretion (this will normally be to those nominated on your Expression of Wish form). Alternative options, although rarely taken up, are for the whole fund can be used to provide a potentially taxable pension from SIPP assets or an annuity policy to your spouse or dependants.
So, the ability to pay out the fund as a tax-free lump sum looks very attractive. But, there can be a catch. If your SIPP includes funds transferred in from a company pension scheme, and you were a controlling director or had earnings in excess of the earnings cap, then only 25% of the current value of the transfer payment may be paid as a tax free cash sum on death. The remaining monies must be used to provide a spouse's or dependant's pension. If you do not leave a surviving spouse or dependant (or you did not earn over the earnings cap or were not a controlling director) then all the fund can be paid as a tax free lump sum to any of your nominated beneficiaries or your estate.
Finally, a word of caution for any members who might be in ill-health and wondering whether or not to commence drawing retirement benefits. If it is thought, by the Capital Taxes office, that a member has deferred taking benefits from the SIPP in a deliberate attempt to enhance the death benefits payable, a tax charge of 35% could be levied. The same might also apply if a member dies within two years of transferring funds from a previous plan with less favorable death benefits (i.e. a Retirement Annuity Contract).
Death whilst in income drawdown
If a member decides to start drawing retirement benefits direct from his SIPP fund, without buying an annuity, we refer to this as "Income Drawdown". If you were to die whilst in Income Drawdown, there are three options available to the Trustees.
- The remaining fund can be paid as a lump sum, less 35% tax.
- The spouse or dependants can use the fund to purchase an annuity.
- The spouse or dependants could continue with the income drawdown.
Under option 1, the remaining fund becomes part of the recipient's estate and, therefore, when they die, their dependants (children/grandchildren) inherit a fund which will again be reduced by inheritance tax charges. Some members with adequate assets outside of the SIPP may therefore prefer to see lump sums going straight to their children.
In other situations where the needs of the spouse and children are less clear-cut, a method known as a "bypass trust" can be used allowing the SIPP member to set up a discretionary trust during their lifetime under which the spouse features amongst the possible beneficiaries. This Trust can then receive the lump sum benefit (if nominated on the Expression of Wish form) at the discretion of the Trustees on the death of the member.
This method has several advantages in that the financial security of the surviving spouse is protected because, as a trustee of the "bypass trust", he/she can allow the income or a capital payment to be made payable to themselves. The Trust is also classed separately to the spouse's own estate, achieving IHT savings if they were to die whilst a capital fund remains in the trust, therefore protecting the interests of the children or grandchildren. The Trust can then remain in existence and benefit the next generation or it can be wound up with the assets being split at the, then, Trustees discretion. Barnett Waddingham are not legal advisers but we work in conjunction with our clients' own solicitors who can normally provide these types of trust.
Death whilst in phased retirement
Phased Retirement is the term used to describe partial drawdown of funds from a SIPP. Each Barnett Waddingham SIPP fund is split into 1,000 segments. A member may be in a situation where just a small amount of retirement income is needed, perhaps because they are still in some sort of employment. In this case, a proportion of the segments will be "vested" for retirement purposes. If you have opted to take Phased Retirement within your SIPP, the "vested" segments can be dealt with as described under the three options above for Death whilst in Income Drawdown and the remaining "unvested" segments can be distributed in the same manner as used for Death before Drawing Retirement Benefits.
Notes
Dependants also means unmarried partners of the same or opposite sex if they were deemed to be financially dependent or interdependent.
Beneficiary would normally mean the member's spouse or children, dependants, persons able to benefit under a trust or any person named on an Expression of Wishes form.
Claire Morley, September 2002.