Discretion matters for pension schemes and their members. If you know your Shakespeare, discretion is ‘the better part of valor’ (Henry IV), meaning better to be cautious than make rash decisions. Also a consideration for pension schemes and members, but not the kind of discretion I want to discuss here.
When pension scheme trustees operate discretion over who receives pension benefits, the benefits will not be subject to inheritance tax (IHT). Discretionary benefits are usually lump sum payments on death in service (normally insured due to the amounts involved) and sometimes also death after retirement payments.
Members are given the opportunity to complete an expression of wish (or nomination) form where they can give the trustees a note of their preferred beneficiaries and the proportion of any benefits they would like paid to each. But these nominations are always (to the surprise of many) not actually binding on the trustees. The trustees have the freedom to choose to whom to pay the benefits – this decision is at their ‘discretion’. The nominations are for guidance only, otherwise the IHT benefit would be lost.
In most cases, trustees will ask for a copy of the deceased’s will and details of financial dependence so they can determine the circumstances of the case before making a decision.
Going against the grain
Sometimes the decision can be straightforward. In other cases, trustees can face a tricky task when there are multiple beneficiaries or the deceased does not nominate relatives. They may choose to follow the member’s expression of wishes. Or after considering all the circumstances available to them and exercising discretion with due care and attention, the trustees may make a decision that is not in line with the member’s nomination.
One area trustees may need watch out for is where direction is switched to discretion. The Supreme Court is ruling on a case (‘Staveley’) where HMRC successfully claimed that a transfer from a S32 policy (where benefits would be paid to the member’s estate) to a personal pension plan (where benefits are discretionary) was tax avoidance as the member was terminally ill. Occupational schemes could see similar cases.
Sometimes trustees may find that their decision is contested. This is becoming more and more common. In fact, death benefit decisions now account for 10% of the Pensions Ombudsman cases, a threefold rise since the advent of pension freedoms when compared to the same period prior to 2015.
Perhaps this is simply a case that large sums of money make it more likely that there will be an aggrieved party who has not received what they thought they should.
Or maybe it’s a lack of understanding of the benefits of discretion over direction. Does the expression of wish form do enough to explain the need for discretion to ensure IHT benefits? Does it explain sufficiently the loss of control to the member over decision making? How many members read the caveat that the trustees will usually follow the member’s wishes but are not bound to and ignore the last part. The key element of the discretion.
It is important that scheme administrators take the opportunity of regular member communications, such as newsletters, benefit statements and summary funding statements to remind members to keep their expression of wish form up to date. A form can be enclosed with traditional print communications, members can be directed to a website to download a form or prompted to contact the administrator by telephone or email.
The more up to date the member’s expression of wish form, the less likely it is that the trustees’ decision will be challenged and the member’s wishes can be fulfilled.