RPSM03109040 - Technical Pages: Protecting pension rights from tax charges: Death benefits: Arrangement types

Types of arrangement providing death benefits

All types of arrangement (defined benefits, cash balance, other money purchase and hybrid) can be used to provide death benefits. Any arrangement type can provide death benefits in either lump sum or pension form (or a combination of both).

Pension arrangements can use insurance policies (term life/life cover policies) to fund the promised death benefits. However it is the form of the death benefits promised to the member under the terms of the pension arrangement that sets the type of arrangement. The arrangement type depends on the pension promise for members, not the wording of the policy that is used as the mechanism to deliver the promise.

Other money purchase arrangements

The amount of benefits provided is wholly dependent on the amount of payments made to the arrangement by or on behalf of the member. An example of benefits provided from an other money purchase arrangement is a return of the member’s fund. Another example would be an arrangement that promised to pay the member the proceeds of an insurance policy.

Arrangements under former personal pension schemes, most retirement annuity contracts (see RPSM03101091) and most small self administered pension schemes will fall into the other money purchase arrangement category.

Cash balance arrangements

The amount of benefits provided is dependent on the amount that has been promised will be made available to provide those benefits. The amount available to provide benefits is not dependent on the payments that have been made by or in respect of the member of the arrangement.

For example a member is promised that £3 million worth of death benefits will be provided. Benefits worth £3 million will be provided regardless of the money that is in the arrangement at any point in time. If there is more than £3 million in the member’s arrangement only £3 million can be provided. Similarly if there is less than £3 million in the arrangement, benefits worth £3 million must still paid. Further funds will need to be put into the arrangement by, for example, the employer so that the promised benefits can be paid.

Defined benefits arrangements

The amount of benefits provided is not dependent on the amount that will be made available to provide benefits. Examples of benefits from such an arrangement are

• a lump sum death benefit of 4 x salary,
• a lump sum of a fixed amount of benefit e.g. £100,000 even if provided by a life cover policy, and
• a dependant’s pension of a fixed amount, e.g. £50,000 pa or 2/3rds of the member’s pension.

However, a fixed amount e.g. £100,000 that is to paid out on death but which has not been expressed in benefit terms, so might be paid in the form of either a pension or a lump sum is not a defined benefit but a cash balance benefit. This is because the form of the benefit will not be decided on until on or after the death so there is no defined benefit. Hybrid arrangements

An arrangement may for instance promise pension benefits on an other money purchase basis if the member survives until retirement age, or a defined benefits lump sum death benefit if they do not. As the benefit to be paid is not known at the outset and only one type of benefit will be paid such an arrangement will be a hybrid arrangement.