Many of us in employment will be aware of a Death in Service benefit stipulated into our employment contract, usually three or four times our annual salaries, but every scheme and employer will differ. It is a valuable benefit that will help to ensure that our loved ones receive a lump sum in the event of our death, regardless of health or age making this unconditional benefit very valuable.
In a typical scenario, Death in Service benefits are paid out to the nominated beneficiaries and little more needs to be considered. However, Death in Service schemes are also subject to the rules of registered pension schemes, meaning that they are subject to the Lifetime Allowance.
What is the Lifetime Allowance?
The Lifetime Allowance is effectively a cap on how much you are allowed to save into a pension and we covered this off recently in our stealth tax blog. The amount has varied since its introduction in 2006, however, it currently sits at £1,073,100. It has been an area of contention in recent news as many members of the NHS Pension scheme have breached the Lifetime Allowance threshold and have been subject to tax charges – but what exactly does this mean for Death in Service schemes?
As Death in Service schemes are subject to the same rules as registered pension schemes, this means that the amount that is paid out forms part of the Lifetime Allowance of £1,073,100. For many people, a Death in Service benefit is very unlikely to breach this value on its own, however, once existing pension arrangements are taken into consideration, then potential issues may arise.
For those in defined contribution pension schemes (also known as money purchase), the value of the fund upon death is tested against the Lifetime Allowance. Should the value of the pension and the amount paid out from the death in service scheme breach the Lifetime Allowance, then there would be a tax charge at a set rate of 55% on any amount above £1,073,100.
Let’s look at an example:
Sarah is 58 and is currently earning £75,000 basic salary, whilst her employer also offers a four times death in service benefit. Sarah has also been saving into defined contribution pension schemes for many years and her fund values currently sit at £900,000. Sarah unexpectedly passed away and her pension and death in service has been paid to her children whom she nominated as her beneficiaries. The amount tested against the Lifetime Allowance is the pension fund value of £900,000 plus the death in service benefit of £300,000 with a total of £1,200,000. As this exceeds the Lifetime Allowance, there will be a tax charge of 55% on the residual value. In monetary terms:
£1,200,000 less £1,073,100 = £126,900 x 55% tax charge = £69,795 tax bill
The tax charge is payable by the beneficiaries, who will liaise with personal representatives of the estate, the scheme administrator and HMRC, which can be a complex and stressful process.
What else can be impacted by having Death in Service Benefits?
As mentioned earlier, the Lifetime Allowance has varied over the years and when there was a decrease in 2012, 2014 and 2016, the government created Fixed Protection, where individuals could benefit from fixing their Lifetime Allowance, but with the caveat that they did not contribute any further savings to their pension schemes, thus limiting their tax liability upon death.
However, where an individual changes employment or death in service scheme (e.g., changing the terms from three times salary to four times salary), this could result in a loss of their protection and result in the beneficiaries paying an even higher tax charge.
What can be done to help?
It can be very easy when a death in service scheme is set up to think about the company, but not the impact on individuals, especially those with high salaries, large pension funds or those who have previously applied for fixed protection.
Such problems must be treated with the utmost care and if you or your employees potentially fall foul of any of the Lifetime Allowance rules, this could create a significant problem for you beneficiaries.
At Alexander Grace, we look to build long term relationships with our clients and highlight potential issues before they arise. We sit down with our clients and understand what it is they wish to achieve personally and financially to meet their plans. With regards to passing on assets, it is very easy to simply focus on inheritance tax, however, we look at the whole situation and can keep you on track to help meet your objectives, both now and in the future. If you are interested in having a conversation with one of our Independent Financial Planners, please get in touch on 01675 443189 or email us on firstname.lastname@example.org
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