A recent determination from the Pensions Ombudsman will be of interest to all trustees and administrators and highlights once again that schemes should have proper procedures for flagging outstanding death benefits that remain unpaid towards the end of the two-year period, so payment can be arranged before tax charges become due.
Lump sum death benefits paid from a registered pension scheme are authorised payments for tax purposes if certain conditions are met. Where a member of a DC pension arrangement dies before age 75, any uncrystallised funds lump sum death benefit must be paid to the beneficiary within two years of the earlier of the date the scheme administrator knew of the death, or could first be reasonably expected to have known of it.
In Bashford, the Pensions Ombudsman (PO) held that a scheme administrator should have made a member's widow aware of the statutory two-year time limit for payment of death benefits to avoid the payment being an unauthorised payment for tax purposes. He also held that if the administrator had done so, the widow would have provided the necessary documents to allow it to make the payment within the time limit.
The PO partially upheld a complaint by the widow of the holder of a retirement annuity contract, who provided the administrator with a grant of probate four years after she informed it of the policyholder's death. The PO directed the administrator to reimburse the widow for the unauthorised payment charge and unauthorised payment surcharge (totalling £36,866) that resulted from the ensuing unauthorised payment, with interest. But he also held that the late payment of these charges after the due date was caused by an accountant instructed by the complainant and was entirely outside the administrator's control. It therefore had no responsibility for the resulting late payment surcharges and interest on late payment (totalling £5,865).
The administrator's failings caused the widow distress and inconvenience for which it was directed to pay £200 in compensation. However, the PO did not make any award for the legal fees claimed, because the complaint was “relatively straightforward”.
In two earlier cases, the PO has held that the trustees of occupational pension schemes have failed in their duty arising under the scheme rules, to pay a lump sum death benefits within two years of the member’s death:
- in Browne in 2013, the PO found that the trustees’ “half-hearted” enquiries of the late member’s mother regarding information needed to award the benefit, and their failure to seek the information elsewhere, constituted maladministration. Any failure by the member’s mother to supply the information was insufficient to limit the trustees’ liability since she had no relationship with them before she was made a beneficiary. The PO directed the trustees to pay the executors a sum equal to the unauthorised payments charge and surcharge (over £23,000), plus interest on this and the net death benefit already paid; and
- in Parizad in 2012, the PO determined that there had been a breach of trust where the trustee deliberately failed to exercise a discretion to pay a lump-sum death benefit within the two-year period prescribed in the scheme rules. The PO upheld a complaint on behalf of a member in respect of whom the trustees initially decided to pay half of a lump-sum death benefit. Due to problems in locating the complainant, the trustees later decided to instead allow the two-year period to lapse and to pay the money to the member's personal representatives, attracting nearly £22,000 in tax. The PO directed the trustees to establish a trust for payment of the death benefit into which they should pay an amount equal to the complainant's untaxed share (£31,375), an option that always had been available under the scheme rules.
The two-year window for death benefits to receive favourable tax treatment is, or should be, well known among pension practitioners. The Bashford determination highlights the risks for scheme administrators and trustees in dealing with death benefits within the two-year limit. Initially, two years may appear to be a generous timeframe within which to deal with the benefits but where issues such as the obtaining the grant of probate cause delays, the two-year deadline may be breached, resulting in tax charges.
As illustrated by the Parizad case, trustees should seek legal advice about death benefit awards that may be out of the ordinary. Here, proper legal advice would have confirmed that the trustees could have charged the cost of setting up a separate trust as a general expense of the scheme, thereby avoiding the dispute which subsequently arose over whether one of the beneficiaries would be willing to give an indemnity in relation to these costs. In some cases, scheme rules provide expressly that trustees may deduct the expenses involved in setting up a separate trust from the death benefit payment.
In Browne the determination shows that the PO can be fairly unforgiving of the trustees. Here, he considered that the two-year window for paying death benefits had been a feature of tax legislation for many years and ought to be well known to trustees. Historically, its purpose was to give trustees sufficient opportunity to identify the potential recipients of death benefits and allow payment to be made. As the PO noted, in a relatively straightforward case there should be no reason to go beyond the statutory time limit.
These cases all highlight that trustees and administrators should have in place proper procedures for flagging outstanding death benefits that remain unpaid towards the end of the two-year period, so payment can be arranged before tax charges become due.