EIM75640 - The taxation of pension income: annuities paid to a dependent, nominee or successor
Overview
Dependants, nominees and successors
What is a dependants’ or nominees’ annuity
When a dependants’ or nominees’ annuity is taxable
When an annuity purchased in the member’s lifetime is tax-free
When an annuity purchased after the member’s death using remaining funds is tax-free
When an annuity purchased using funds from a drawdown fund is tax-free
Successors’ annuities
Taxable amount of annuity
Overview
This guidance relates to annuities payable to a dependant, nominee or a successor where the annuity is paid under, or purchased using funds of:
- a registered pension scheme
- an overseas pension scheme
- a relevant non-UK scheme (RNUKS)
EIM75600 provides guidance on the meaning of the terms ‘overseas pension scheme’ and ‘relevant non-UK scheme’ (RNUKS).
Any annuity paid before 6 April 2015 is taxable as pension income.
Any annuity paid in respect of the death of a member or beneficiary aged 75 or older is taxable.
Any annuity paid in respect of a member or beneficiary who died before 3 December 2014 is taxable.
Annuity payments made on or after 6 April 2015 in respect of a member or beneficiary who died on or after 3 December 2014 aged under 75 may be tax-free. The conditions for tax-free payment vary depending on the type of annuity and how it was purchased.
To work out the correct tax treatment for payments, identify:
- the type of person receiving the annuity (dependant, nominee, successor or other)
- the source of the funds used to purchase the annuity (registered pension scheme, overseas pension scheme, RNUKS or other)
- the type of annuity by reference to the rules for authorised pension payments made by a registered pension scheme
Dependants, nominees and successors
The term ‘dependant’ includes a member’s spouse, civil partner and children aged under 23. PTM071200 provides full details of who can be a dependant.
Broadly a nominee is someone who is not a dependant but who has been nominated by the member to receive benefits from the scheme following the member’s death.
A successor is someone who has been nominated by a dependant, nominee or a previous successor (the beneficiary) to receive benefits from the scheme following the beneficiary’s death.
PTM071200 provides guidance on the full meaning of the term ‘dependant’. PTM071300 provides detailed guidance on the meaning of the terms ‘nominee’ and ‘successor’.
What is a dependants’ or nominees’ annuity
Paragraphs 17 and 27AA schedule 28 Finance Act 2004
A dependants’ annuity is an annuity purchased from an insurance company using funds from a money purchase pension arrangement. It may be purchased:
- at the same time a member secures payment of their pension by purchasing a lifetime annuity
- after the member’s death using any remainder of the member’s funds
- after the member’s death using funds held under a dependant’s drawdown fund.
A nominees’ annuity is an annuity purchased from an insurance company using funds from a money purchase pension arrangement. It may be purchased:
- at the same time a member secures payment of their pension by purchasing a lifetime annuity - if the member becomes entitled to their lifetime annuity after 5 April 2015
- after the member’s death where the member dies on or after 3 December 2014 and the nominee becomes entitled to the annuity after 5 April 2015; it may be purchased using any remainder of the member’s funds or funds held under a nominee’s drawdown fund.
See PTM072200 for detailed guidance on the payment conditions for these types of annuity.
How and when the annuity is purchased affects the legislation that specifies how the annuity is to be taxed, and the conditions for tax-free payment.
When a dependants’ or nominees’ annuity is taxable
Sections 579A, 646B and 646C ITEPA 2003
Before 6 April 2015 payment of a dependants’ annuity was taxable as pension income of the dependant. A nominees’ annuity could not be paid before 6 April 2015.
From 6 April 2015 a dependants’ or nominees’ annuity is taxable if it is payable in respect of a member who:
- died before 3 December 2014 at any age
- died on or after 3 December 2014 aged 75 or older
- died on or after 3 December 2014 aged under 75 and the conditions for tax-free payment are not met.
Tax-free payments of dependants’ or nominees’ annuity are only possible for payments made on or after 6 April 2015. The conditions that need to be met for tax-free payments vary slightly depending on how the annuity was purchased. The following sections provide more details.
When an annuity purchased in the member’s lifetime is tax-free
Sections 646B(3)/646D(3) ITEPA 2003
Payments of a dependants’ or nominees’ annuity that was purchased together with the member’s lifetime annuity (a related annuity – see PTM072200) will be tax-free if it is paid in respect of a member who died on or after 3 December 2014 aged under 75, and no annuity payment was made to the dependant or nominee under the contract before 6 April 2015. If the annuity contract is a replacement for a previous dependants’ annuity contract, the annuity will be tax-free only if none of the previous dependants’ annuity contracts made payments of dependants’ annuity before 6 April 2015.
When an annuity purchased after the member’s death using remaining funds is tax-free
Sections 646B(1)/646D(1) ITEPA 2003
Where the dependants’ or nominees’ annuity was purchased after the member’s death using either or both of remaining drawdown funds (where the member had drawdown pension) and uncrystallised funds (funds that have not yet been put aside or used to provide benefits), payments made on or after 6 April 2015 will be tax-free if both of the following conditions are met:
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the annuity must be paid in respect of a member who died on or after 3 December 2014 aged under 75
-
no annuity is paid under the contract before 6 April 2015 - if the annuity contract is a replacement for a previous dependants’ annuity contract, the annuity will be tax-free only if none of the previous dependants’ annuity contracts made payments of dependants’ annuity before 6 April 2015.
There is an extra condition for tax-free payment where the annuity purchase is made using uncrystallised funds from a registered pension scheme. To be paid tax-free, the dependant or nominee must become entitled to the annuity within 2 years of the earlier of:
- the day the registered pension scheme administrator first knew of the member’s death
- the day they could first reasonably have been expected to know of it.
This is known as ‘the relevant two-year period’.
If the annuity contract is a replacement for a previous contract purchased using uncrystallised funds, the annuity will be tax-free only if the beneficiary became entitled to the annuity under the previous contract within the relevant two-year period.
When an annuity purchased using funds from a drawdown fund is tax-free
Sections 646C(1), (4) to (6)/646E(1), (4) and (5) ITEPA 2003
An individual who is a nominee and has nominees’ drawdown pension can use part or all of their nominee’s flexi-access drawdown fund to purchase a nominees’ annuity or nominees’ short-term annuity.
An individual who is a dependant and has dependants’ drawdown pension can use part or all of their dependant’s drawdown funds to purchase a dependants’ annuity or dependants’ short-term annuity.
The conditions for tax-free payment of the annuity depend on when the dependant originally designated funds to provide them with a drawdown pension.
Funds designated on or after 6 April 2015
Where an annuity has been purchased using funds from a dependant’s or nominee’s flexi-access drawdown fund it will be tax-free if payable in respect of a member who died on or after 3 December 2014 aged under 75.
Where the annuity is purchased using funds from a registered pension scheme, there is an extra condition for tax-free payment where the funds used to create the dependant’s or nominee’s flexi-access drawdown fund included uncrystallised funds. For the annuity payment to be tax-free, the nominee or dependant must have designated funds into flexi-access drawdown within 2 years of the earlier of
- the day the registered pension scheme administrator first knew of the member’s death
- the day they could first reasonably have been expected to know of it.
Dependant’s drawdown funds designated before 6 April 2015
Where an annuity has been purchased using funds from a dependant’s drawdown pension fund created before 6 April 2015 or a dependant’s flexi-access drawdown fund that was created from a converted dependant’s drawdown pension, an annuity payable in respect of a member who died on or after 3 December 2014 aged under 75 will be tax-free if none of the following payments were made before 6 April 2015:
-
dependants’ drawdown pension (either as income withdrawal or short-term annuity)
-
dependants’ annuity made under any contract purchased using funds from the dependant’s drawdown pension fund/flexi-access drawdown fund.
PTM072440 and PTM072450 explain how a dependant’s drawdown pension fund can be converted to a dependant’s flexi-access drawdown fund.
Successors’ annuities
Sections 646B(2)/646D(2) and 646C/646E(2) ITEPA 2003
A successors’ annuity is an annuity purchased after the death of a beneficiary (a dependant, nominee or a previous successor) on or after 3 December 2014. It can be purchased using the remainder of the beneficiary’s drawdown fund. Alternatively, an individual who is a successor and has a successors’ drawdown pension can use part or all of their successor’s flexi-access drawdown fund to purchase the annuity.
Regardless of how the annuity is purchased, the successor cannot be entitled to it before 6 April 2015.
A successors’ annuity is tax-free if is payable in respect of a beneficiary who dies on or after 3 December 2014 aged under 75.
Payment of a successors’ annuity is taxable if it is paid in respect of a beneficiary who died before aged 75 or older.
See PTM072200 for detailed guidance on the payment conditions for this type of annuity.
Taxable amount of annuity
Where the annuity is taxable as pension income the taxable amount depends on the source of the annuity.
Registered pension schemes
Sections 579A, 579B, 579CA and 683 ITEPA 2003
Where an annuity payable to a dependant, nominee or successor is taxable the recipient is liable to pay tax whether or not they are UK resident.
The amount chargeable to tax is the amount of annuity that accrues to the individual in the tax year. This may be different to the amount of annuity they actually receive in the tax year.
Certain annuity payments made whilst an individual is temporarily non-resident may become chargeable to tax on their return to the UK. EIM75450 explains when this may happen.
PAYE applies to pensions, including annuities, paid under a registered pension scheme. The payer of the annuity must apply the PAYE rules before paying the annuity. The exception to this rule is pension income that becomes subject to UK tax under the temporary non-residence provisions (see EIM75450).
Overseas pension schemes and relevant non-UK schemes (RNUKS)
Sections 573, 575 to 576A and 613 ITEPA 2003
Where an annuity payable to a dependant, nominee or successor is taxable the recipient is liable to pay tax only if they are UK resident.
Where an annuity is taxable, unless the remittance basis or temporary non-residence provisions apply the taxable amount is the full amount of the annuity arising in the tax year.
These annuities are ‘relevant foreign income’ for the purposes of chapters 2, 3 and 4 of Part 8 ITTOIA 2005. For individuals subject to the remittance basis this means tax is due when the annuity is remitted to the UK (see RDRM31030).
Certain annuity payments made whilst an individual is temporarily non-resident may be ‘relevant withdrawals’ that become chargeable to tax on the individual’s return to the UK. EIM75450 explains when this may happen.
For individuals who return to the UK in 2017 to 2018 or a later tax year, that taxable amount depends on when the annuity was actually paid. Where the annuity was actually paid after 5 April 2017, the full amount of the payment is taxable. Where the annuity was actually paid before 2017 to 2018, the taxable amount is 90% of the amount paid before 6 April 2017.
Position before 6 April 2017
For annuities arising before 6 April 2017, unless the remittance basis applies the taxable amount is 90% of the amount of annuity arising in the tax year. For individuals subject to the remittance basis the taxable amount is the full amount of the annuity remitted to the UK. The 10% deduction is not available for individuals subject to the remittance basis (see RDRM10430).