Question 2.12: How are my death benefits treated for tax purposes?
As has already been stated (see question 2.4) benefits are taken into account for tax only when they come into payment. Any benefits which the Revenue Commissioners allow to be paid as lump sums in normal circumstances are not taxed. Benefits payable in pension form are subject to tax under the PAYE system, so the tax payable on them will be determined by the individual tax position of whoever is receiving the payment.
There is another tax to which death benefits can be exposed. Benefits paid on death are regarded as part of your estate for the purposes of Inheritance Tax, even though you cannot normally control who gets these benefits by means of your will.
For the purposes of inheritance tax, death benefits are treated like every other inheritance. The amount of tax payable (if any) depends on who is receiving the benefit and the relationship to you. For example, if the only beneficiary is your husband or wife, no inheritance tax would be payable. If a child or children receive the benefit, anything they get from the pension scheme will be added to whatever else they have inherited for the purpose of calculating whether they are liable to tax or not. The thresholds for relatives other than children are low and, for non-relatives, even lower still. In summary, therefore, if your death benefit is inherited by anyone except your lawful spouse, there is at least a possibility that inheritance tax will be payable. Non-relatives, such as a dependant who is not legally married to you, are the most likely people to pay substantial amounts of inheritance tax. The trustees will want to satisfy themselves that the liability for inheritance tax has been taken care of before they pay out the full death benefit, as they could be held liable for payment of the tax otherwise.