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Death Benefits for Defined Benefit Schemes

15 min read 6 Oct 22


Find out about the types of death benefits that can be paid from a defined benefit scheme and how they’re taxed.

  • Defined benefit schemes usually offer lump sum death benefits and scheme pension.

  • The lump sum death benefit will usually be a set amount or a multiple of salary.

  • Lump sum death benefits are tax-free if the member dies under age 75, the lump sum is within the member’s lifetime allowance and it is paid within two years of the scheme administrator becoming aware of death.

  • Scheme pension is usually based on a percentage of the member’s pension entitlement.

  • Scheme pension is taxable regardless of the member's age when they die. 

There have been a few recent high profile court cases so changes may be on the way but currently, occupational pension scheme rules will detail what benefits are payable and who would be classed as dependants or beneficiaries. The benefits provided may include a lump sum death benefit and / or dependant’s scheme pension.

HMRC’s definition of a "dependant" is broadly:

  • the member's widow(er) or civil partner at the time of the member's death

  • a child of the member who is under the age 23

  • a child of the member who, in the opinion of the scheme administrator, is dependant on the member, because of physical or mental impairment, at the date of the member's death

  • a person who wasn't married or in a civil partnership and is not a child of the member, who in the opinion of the scheme administrator is, at the date of the member’s death:

    • financially dependent on the member

    • in a financial relationship of mutual dependency with the member; or

    • dependant on the member due to mental or physical impairment.

Pension scheme rules may restrict to a narrower definition of dependant (for example, a younger cessation age for a child's pension). The extended meaning of ‘dependant’ for a child of the member who reaches age 23 on or after 16 September 2016 applying to defined contribution schemes doesn’t apply in respect of dependant’s scheme pensions. So, if the child is not a dependant because of physical or mental impairment, the pension must cease by age 23.

Certain factors are important when considering death benefits. Whether the member died before or after 75, if the death happened pre or post crystallisation and how the benefits are to be paid. Achieving age 75 is classed as a crystallisation event (although the member may not have actually crystallised the pension) - as such post age 75 all death benefits (crystallised or uncrystallised) are treated as post-crystallisation.

This is a lump sum which is paid from a defined benefit arrangement. There is no limit on the level of defined benefits lump sum death benefit that can be paid from a defined benefits scheme. DBLSDB is usually only payable on death before retirement. The amount paid may be:

  • a set amount promised by the scheme,

  • linked to the member's salary at the time of death or

  • based on some other measure, but

  • cannot be based on the amount of funds available to provide the benefit (if that was the case then this is not a defined benefit lump sum death benefit).

Since 6 April 2016, there are no time limits on the payment of a DBLSDB. However, if the member dies under 75 and it is paid outside the two-year period, there are taxation implications which are discussed below. 

A lump sum can’t be a DBLSDB if it meets the conditions for a:

  • pension protection lump sum death benefit

  • trivial commutation lump sum death benefit

  • winding-up lump sum death benefit.

Paragraph 13 Schedule 29 Finance Act 2004

The lump sum will be specified by the scheme rules. This can be provided directly from the scheme (where the scheme self-insured the cover) or may be insured through an assurance arrangement. HMRC don't limit the sum that can be paid on death. Generally, the scheme will set an amount of lump sum payable if a member dies before taking retirement benefit (usually expressed as a multiple of salary, for example, four times salary). 

A term-assurance policy that pays out a benefit on the death of the member by reference to the individual's salary is providing a defined benefit. However a policy that pays out a set monetary amount is providing a cash balance benefit and as such cannot be classed as a defined benefit lump sum death benefit and is likely to be paid as an uncrystallised funds lump sum death benefit. 

A lump sum payable under a five-year guarantee can be treated as a DBLSDB as long as it meets the conditions of being paid from a DB scheme and being based on a defined calculation rather than based on the amount of funds available. The member must also have not asked for the guarantee to be paid as a pension protection lump sum death benefit.

It’s not uncommon for schemes to use this approach as an alternative to commuting five-year guarantee periods, which ceased to be allowable from 6 April 2006 (A-Day).

HMRC give the following examples of lump sums payable on death that would qualify as a defined benefits lump sum death benefit:

  • a multiple of earnings, such as 2 x final salary (eg group life assurance payable on death in service), or

  • a multiple of service eg £500 for each year of service with the employer, or

  • a multiple of another factor eg 3 x prospective pension or 10% of the employer's profits in the accounting period before the member's death, or

  • a lump sum of a fixed amount of benefit eg £100,000 even if provided by a life cover policy NB read note below.

However, a fixed amount of £100,000 paid out on death but not expressed in benefit terms and might be paid as either a pension or a lump sum (ie where the form of benefit is to be decided on or after death), is not a defined benefit LSDB but a cash balance benefit.

A spouse's guaranteed minimum pension (GMP) can’t be commuted for a DBLSDB – it must be paid either as a pension, or as a trivial commutation LSDB. However, the calculation of the DBLSDB can include the value of the member's GMP. For example, the member's pension at the date of death was £1000 per month, including £200 pm GMP. There is a DBLSDB payable, which is calculated as 5 x the member's pension at date of death. The calculation of the DBLSDB can include the value of the member's GMP as long as the scheme still meets its obligation of paying the spouse the spouse’s GMP.

A dependant’s scheme pension may be provided under both a money purchase arrangement and a defined benefits arrangement. However, it is more likely to be paid under a DB scheme as defined benefit schemes can only offer scheme pension. If the member wants to access different options at crystallisation, they’ll have to transfer their benefits to another type of scheme. However, unfunded public sector pension schemes cannot be transferred to provide flexible benefits.

Scheme pension may be paid either by the scheme administrator of the registered pension scheme providing the pension or, if the scheme’s liability to pay the pension has been secured through the purchase of an annuity contract, by the insurance company underwriting that contract.

A dependant’s scheme pension:

  • does not have to be paid for the life of the dependant, it may be stopped at any time in accordance with the rules of the scheme or the terms of the annuity contract,

  • does not have to be paid annually,

  • may be reduced at any time in accordance with the rules of the scheme or the terms of the annuity contract,

  • can’t be guaranteed for a certain term or have pension protection, pension commencement lump sum, or provide a benefit to someone else on the death of the dependant.

Dependant’s scheme pension may be in the form of:

  • pension for spouse, partner, or civil partner; and / or

  • children's pension (normally paid to a certain age, longer only in the case of a physically or mentally impaired child).

If there are no dependants (as defined by the scheme rules and/or HMRC rules), a lump sum (in addition to any DBLSDB, detailed above) may be payable. A dependant’s scheme pension does not need to come into payment immediately following the death of the member and if there are multiple dependants the payments can technically start at different times. It may be deferred as there are continuing guaranteed pension payments, or because the dependant is still young. Again full details of whether this is allowed will be set out in the scheme rules.

The amount of dependant's scheme pension is limited in certain circumstances:

  • if the member dies on or after age 75, and

  • if the member dies after 5 April 2006, and

  • a scheme pension was being paid at the member's date of death, or he or she was prospectively entitled to one.

If these conditions are met, generally the aggregate dependant's scheme pension payable to any dependants of the member must not exceed 100% of the member's scheme pension payable at the date he or she died. 

The calculation of the initial member pension limit is prescribed, but is broadly equal to 100% of the pension paid to the member in the 12 months preceding his date of death, plus 5% of any pension commencement lump sum paid. If the member has not been in receipt of a pension for more than 12 months, the dependant's scheme pension is the amount he would have received in the first 12 months.

The subsequent increases that can be granted to a dependant's scheme pension that has been limited are also limited. 

Different limits may apply to small pension schemes, under 50 members etc.

For full details see HMRC Pensions Tax Manual PTM072120

Where the member's scheme pension was in payment on 5 April 2006 and the member dies subsequent to that date, but before reaching age 75, the limit on the dependant’s scheme pension does not apply.

The Taxation of Pension Schemes (Transitional Provisions) Order 2006/572

Regulations provide for the transfer of sums / assets by registered pension schemes and insurance companies, where those sums / assets represent pensions in payment. A transfer of sums / assets from a dependant's scheme pension between registered pension schemes is only treated as being a recognised transfer if those sums or assets are applied for the provision of a new dependant's scheme pension. Where the dependant's scheme pension is being paid by an insurance company, the amount transferred is treated as an unauthorised payment if a new dependant's scheme pension is not provided.

The Registered Pension Schemes (Transfer of Sums and Assets) Regulations 2006

Protected rights

From 6 April 2012 protected rights ceased to exist, so the death benefits payable have no special restrictions that used to exist. A schemes rules / documentation could however have restrictions depending on how their rules are framed.