‘I took a lump sum from my late wife's pension. Why have I been taxed?'

Telegraph

15 hours ago

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Dear Charlene,
My wife died on February 1 this year. She was the recipient of a small pension paid from her former employer.
I was aware that I had an entitlement to half her pension. However, when the offer letter arrived, it stated that I was entitled to take a lump sum, which I have done. I've sent you copies of the letters from the scheme.
When payment was made by the pension fund, income tax was deducted at 20pc on the whole amount. This is my correct tax rate for other income.
Although this was my wife's pension fund, am I entitled to any of it tax-free? I've read that some pensions can be paid tax-free when someone dies. Would that be the whole amount tax-free, or just the 25pc allowance, or nothing at all?
When we retired in 2001, our pension funds did not come anywhere close to the new maximum allowance of £268,275.
Sincerely yours,
– Gary
Dear Gary,
Please accept my condolences on the death of your wife.
I've had a look at the documentation you've sent, and I'm afraid you are unlikely to be due any tax-free payments from your wife's former scheme, for reasons I will explain. I also think HMRC has probably applied the correct tax rate to the lump sum you've been paid.
Your late wife was receiving a 'scheme pension' from her former employer's scheme, which is a type of secure pension, payable directly from an employer's defined benefit scheme. The exact details vary, as they depend on the rules for each scheme, but benefits can be paid to a spouse or dependants when the original pension member passes away.
Where retirement benefits have already started, and have been in payment for some time, the option is usually a reduced pension to a surviving spouse or other dependant. As you mention, your wife's scheme would have paid you 50pc of her ongoing pension.
Some dependant's pensions can be commuted and taken as a lump sum if worth £30,000 or less. In pensions jargon, this is known as a 'trivial commutation lump sum death benefit', but put simply, involves exchanging the ongoing small pension for a lump sum that ends your rights to ongoing payments from the scheme. This is the option you chose.
Taxation
A spouse's pension (including one commuted as a lump sum) from a defined benefit scheme will be taxable as income for whoever receives it – even if the original pension holder died before age 75. This is different to the death benefits that can be paid from other types of pensions, like self-invested personal pensions (Sipps).
For defined contribution schemes where there is an unused pension pot, a beneficiary will not pay income tax on what they receive if the member passed away before reaching age 75. Income tax is payable on withdrawals paid to beneficiaries of a pension holder who died after reaching age 75, and unused pots will be included in estates for inheritance tax from April 6 2027.
As you've mentioned, the scheme administrator has deducted 20pc income tax from the whole of the lump sum payable to you. Based on what you've told me, and that you've mentioned you're already a basic (20pc) taxpayer, I think this was the correct way to tax the payment.
You'd already be a basic-rate taxpayer if you are receiving your state pension and this, together with any other pensions or taxable income, is worth more than the tax-free personal allowance of £12,570 each year, but less than £50,270.
Anyone who thinks they have been overtaxed on a lump sum payment paid when someone has died can contact HMRC. It has different forms depending on the situation, and will usually process any repayments within 30 days.
Tax-free cash allowance
When someone accesses their own pension, they can usually take up to 25pc of the value as a tax-free lump sum. But there is also an overall cap on the value of the tax-free lump sums someone can receive from their pensions in their lifetime. This is the lump sum allowance of £268,275 that you've referred to.
Unfortunately, you do not inherit unused lump sum allowance from other people. As I've mentioned above, some death benefits can be paid entirely tax-free if the pension holder died before age 75, but for defined benefit pensions, any spouse's or dependant's pension will always be taxable.
I hope I've explained how and why you've paid tax on the lump sum. If you do think you might have paid too much tax, then please do get in contact with HMRC.
Yours sincerely,
– Charlene
Charlene Young is a pensions and savings expert at online investment platform AJ Bell. Her columns should not be taken as advice or as a personal recommendation, but as a starting point for readers to undertake their own further research.