Just double checking…was there a valid Expression of Wish (aka nomination) form in place? The fact it was being paid to the estate suggests not, but it wouldn’t be the first time an organisation has missed the fact there was one on file somewhere. The family may have a copy/know if the deceased had completed one, and not volunteered the information because they didn’t realise it was important (and nobody asked them).
Otherwise the local authority (?presume the Local Government Pension Scheme) may make payment to the estate. Taken from a random LA website a minute ago:
In the event that you pass away, we can normally pay the death grant straight to your nominated person(s) without waiting for probate. The tax office may consider the money excluded from your estate and not deduct any inheritance tax. However, if you do not make a nomination, we may have to pay your death grant into your estate and it will be dealt with according to the terms of the law.
You might ask the pension representative why they have described it as ‘a grey area’, since the LGPS Regulations make it clear the payment is discretionary for active members (if the member wasn’t an active member, you’d need to check the Regs):
Death grants: active members
40.—(1) If an active member dies before attaining the age of 75, an administering authority shall pay a death grant.
(2) The appropriate administering authority may, at its absolute discretion, pay the death grant to or for the benefit of the member’s nominee, personal representatives or any person appearing to the authority to have been a relative or dependent of the member.
(3) The death grant is three times the member’s annual assumed pensionable pay calculated in accordance with regulation 21(4) as at the date of the member’s death**[F1, but where in the opinion of an IRMP the member was at the date of death in part time service wholly or partly as a result of the condition that caused or contributed to the member’s death, no account is to be taken of any reduction in pensionable pay due to such reduction in service as is attributable to that condition]**.
(4) If the administering authority has not made payments under paragraph (1) equalling in aggregate the member’s death grant before the expiry of two years beginning with the date of the member’s death or, where the administering authority did not know about the member’s death within that period, beginning with the date on which the administering authority could reasonably be expected to have become aware of the member’s death, they must pay an amount equal to the shortfall to the member’s personal representatives.
[F2(5) In the case of an active member who is also a deferred member, pensioner member or deferred pensioner member of the Scheme, no death grant is payable under regulations 43 (death grants: deferred members) or 46 (death grants: pensioner members) but if the amount that would be payable under any of those regulations would be higher than the amount payable under this regulation, the amount payable under this regulation is that higher amount.]
If the payment is made at the discretion of the administering authority, then I would expect it to be covered by this:
In most cases, lump sum death benefits are paid at the discretion of the pension scheme trustees or providers even where there is a nomination that expresses a wish as to the beneficiary. They are not then part of the estate or chargeable to Inheritance Tax.
Again, I’d ask the pension representative where the uncertainty creeps in. It may simply be that age-old misunderstanding that any pension benefits/DIS lump sums paid to the estate are automatically subject to IHT - checking the point with HMRC would seem the logical route here to clarify beyond doubt.
When a lump sum is paid more than 2 years after the death (or 2 years from when the scheme administrator could reasonably have known of the death), it is subject to a 45% tax Special Lump Sum tax charge OR treated as income/taxed at the marginal rate of the recipient. For the latter to apply, it must be paid to a ‘qualifying person’.
See PTM073010 - Death benefits: lump sums: tax on authorised lump sum death benefits paid on or after 6 April 2016 - HMRC internal manual - GOV.UK and note the sections:
Types of tax charges on authorised lump sum death benefits
Section 206 Finance Act 2004
Sections 579A, 637H to 637N Income Tax (Earnings and Pensions) Act 2003
The detailed guidance for each type of authorised lump sum death benefit (PTM073000) explains the circumstances in which a payment is tax-free and when it is taxable.
Where the authorised lump sum death benefit is taxable, the tax treatment depends on who receives the payment. The tax charge is either:
- income tax as pension income of the recipient, or
- the special lump sum death benefits charge.
When the special lump sum death benefits charge applies
Section 206 Finance Act 2004
637H(4) and (6), 637I(4), 637J(4) and (6), 637K(4), 637L(4) and (6), 637M(4) and (6) Income Tax (Earnings and Pensions) Act 2003
If a:
- defined benefits lump sum death benefit,
- uncrystallised funds lump sum death benefit,
- pension protection lump sum death benefit,
- annuity protection lump sum death benefit,
- drawdown pension fund lump sum death benefit, or
- flexi-access drawdown fund lump sum death benefit
paid on or after 6 April 2016 is taxable and it is paid to a ‘non-qualifying person’ the lump sum is subject to special lump sum death benefit charge.
For information about this tax charge go to the section Special lump sum death benefits charge on payments made on or after 6 April 2016.
Non-qualifying persons
Section 206(9) Finance Act 2004
A non-qualifying person is someone who is not an individual, e.g. a company, or an individual receiving the lump sum in their capacity as a:
- trustee (other than a bare trustee),
- personal representative,
- director of a company,
- partner in a firm, or
- member of a limited liability partnership.
But note as above - worth checking to see whether the authority has any responsibility for making good the tax deduction (I don’t know - I don’t deal regularly with public sector schemes).
(4) If the administering authority has not made payments under paragraph (1) equalling in aggregate the member’s death grant before the expiry of two years beginning with the date of the member’s death or, where the administering authority did not know about the member’s death within that period, beginning with the date on which the administering authority could reasonably be expected to have become aware of the member’s death, they must pay an amount equal to the shortfall to the member’s personal representatives.