Many individuals drawing pensions from defined benefit (DB) schemes, such as the Lloyds Bank final salary pension scheme, are seeking clarity on how inheritance tax (IHT) rules might affect their beneficiaries. The concern stems from broader discussions around pension taxation and recent legislative changes, particularly the abolition of the pension lifetime allowance from April 2024.
Historically, defined benefit pensions have been treated differently from defined contribution (DC) schemes for inheritance tax purposes. When a member of a DB scheme dies, the remaining benefits, often a spouse's pension or a lump sum, typically pass directly to the nominated beneficiaries according to the scheme's rules. These benefits usually do not form part of the deceased's taxable estate and are therefore not subject to the standard 40% inheritance tax rate that applies to estates valued above the nil-rate band (currently £325,000 per individual, or £650,000 for married couples/civil partners).
The critical factor is that the scheme's trustees, rather than the individual, own the underlying assets. The member has a right to a specified income, not ownership of a capital sum that can be passed on as part of their estate. Therefore, for most defined benefit schemes, any ongoing payments to a surviving spouse or dependents, or any death-in-service lump sum, are generally paid free of IHT. However, it is crucial for individuals to understand the specific terms and conditions of their particular Lloyds Bank pension scheme, as rules can vary.
While IHT is generally not a direct concern for DB pensions, the abolition of the pension lifetime allowance (LTA) from 6 April 2024 does introduce new considerations for beneficiaries. Previously, if an individual's total pension benefits exceeded the LTA (which was £1,073,100 before its abolition), any excess taken as a lump sum was subject to a 55% tax charge. Under the new regime, there is no LTA charge. Instead, a new 'lump sum and death benefit allowance' has been introduced, which is capped at £1,073,100. This means that beneficiaries can receive tax-free lump sums up to this amount, or the value of the pension pot if lower. Any lump sums paid out over this allowance, whether from a DB or DC scheme, will now be subject to the beneficiary's marginal rate of income tax.
For those drawing a pension from a scheme like Lloyds' final salary pension, this change is less likely to affect the core ongoing spouse's pension, which remains taxable as income for the recipient but not typically subject to IHT. However, if there are any significant lump sum death benefits payable from the scheme, the new lump sum and death benefit allowance will apply. It is always advisable for individuals to review their nomination forms with their pension scheme administrator to ensure their wishes regarding beneficiaries are up-to-date and understood within the current tax framework. For personalised advice on estate planning and pension benefits, consulting a qualified financial adviser is recommended.