Tax-free lump sums after death

There are certain lump sums that will be paid out to beneficiaries after a pension member dies, most of these lump sums may produce a tax-free element. These lump sums are:

• Pension protection lump sum death benefit
• Annuity protection lump sum death benefit
• Charity lump sum death benefit
• Trivial commutation lump sum death benefit
• Uncrystallised funds lump sum death benefit
• Defined benefit lump sum death benefit
• Drawdown pension fund lump sum death benefit
• Flexi-access drawdown lump sum death benefit

The amount that is tax-free is the amount within the permitted maximum, which is defined separately for each type of lump sum.  The tax-free element will use up ILSDBA, reducing the available allowance until there is none left.

1. How to work out remaining ILSDBA

The the amount of death benefit lump sum that is tax-free will generally be linked to the remaining ILSDBA. To calculate remaining ILSDBA you need to first take into account any money crystallised before 6/4/24. Details on how to account for previously used lifetime allowance please see the standard transitional calculation on our Transitional regime for past crystallisations page. After accounting for previously used lifetime allowance you need to deduct from ILSDBA the tax- free portion of any lump sums that were taken whilst alive.

2. Pension protection lump sum death benefit & Annuity protection lump sum death benefit

These are lump sums paid from either a defined benefit scheme or annuity where there is a guaranteed lump sum on death.

If the deceased dies before 75, any amount within the permitted maximum is tax free and will use up ILSDBA. Any excess is taxable as income.

The permitted maximum is:

Other protection types will be based on the standard permitted maximum but their ILSDBA will be modified by the protection type.

If the deceased dies 75 or over the entire amount is taxable. If paid to an individual the tax will be marginal rate. If paid to a non-individual the tax will be the special lump sum death benefit charge (45%).

3. Charity lump sum death benefit + trivial commutation lump sum death benefit

A Charity lump death benefit can be paid to a charity nominated by the member where there are no dependants of the member at the time it is paid. A charity lump sum death benefit is tax-free and does not use up ILSDBA.

Broadly, a trivial commutation lump sum death benefit is where a lump sum is paid to a person that is entitled to a small dependant’s pension. The payment must extinguish the pension due to that dependant and is no more than £30,000. The entire value is taxable and it does not use up ILSDBA.

4. All other lump sum death benefits

All other lump sum death benefits are treated the same way. These lump sums are:

• Uncrystallised funds lump sum death benefit
• Defined benefit lump sum death benefit
• Drawdown pension fund lump sum death benefit
• Flexi-access drawdown lump sum death benefit

If the deceased dies before 75, and the lump sum is paid within 2 years, any amount within the permitted maximum is tax-free and will use up ILSDBA. Any excess is taxable as income.

If the deceased dies before 75, and the lump sum is paid after 2 years, the entire amount is taxable.

If the deceased dies 75 or over the entire amount is taxable.

The tax rate will be marginal rate where paid to an individual or 45% (special lump sum death benefit charge) if paid to a non-individual.

5. Previous crystallisations

Any death benefit that comes from money that was crystallised prior to 6/4/24 will not be tested against ILSDBA however past crystallisations do reduce the remaining ILSDBA that other death benefit lump sums are tested against. We are awaiting further clarification from HMRC about how this works where the original money crystallised before 6/4/24 but was later designated to beneficiary drawdown after 5/4/24, and then a lump sum death benefit is paid from the beneficiary drawdown.

Details of the transitional regime that deals with crystallisations prior to 6/4/24 can be found here.