Today many employers look to provide their employees with Death in Service benefits which, thanks to tax relief on premiums and increasing longevity, are considered relatively economical in relation to the level of benefits provided.
Typically, in the event of a successful claim, the Death in Service benefit is paid out to the deceased’s beneficiaries. As Death in Service schemes are subject to the rules of registered pension schemes, the maximum amount that can be paid out before a tax charge is due will be limited to the maximum unused pension lifetime allowance which stands at £1.0731 million from 6 April 2020.
Although a maximum payout of £1.0731 million appears to give more than enough headroom for all but the higher earners, the lifetime allowance needs to accommodate the deceased’s entire lifetime pension savings too.
Consequently, if the total value of the Death in Service payout plus the cumulative value of the deceased’s pensions exceed the lifetime allowance, a tax charge of 55% could be payable on the excess. Those approaching retirement with larger salaries and pension funds should therefore take a close look at their current arrangements. Aware that this could cause an issue, the Government has allowed the introduction of ‘excepted’ life policies, such as Relevant Life policies, which circumvent this problem.
Like Death in Service (up to a certain amount), payouts from a Relevant Life policy are tax free, and the premiums are tax relievable for the employer. Furthermore, the Relevant Life policy premiums are not classed as a benefit in kind for the employee. Most importantly, the amount paid out would not be tested against the lifetime allowance, and therefore there is no liability to a 55% tax charge. It should be noted that ‘excepted’ plans such as Relevant Life policies can only be written on a single life basis, and the applicable premiums could be higher.
The fact remains, however, that there could be more tax-efficient ways of providing for a family on death, especially for those pushing the limits of the lifetime allowance.
Death in Service and Fixed Protection
When the Government reduced the lifetime allowance in 2012, 2014 and in 2016, it offered individuals the chance to ‘fix’ their lifetime allowances through Fixed Protection 2012, 2014 and 2016, but on the proviso that no further ‘benefit accrual’ would take place.
That is, they had to cease making pension contributions and could not join any new pension arrangements after Fixed Protection had been put in place (unless the purpose of that arrangement was to receive a permitted transfer of existing pension benefits). Otherwise, their Fixed Protection would be lost. Sounds easy enough...
Well, what many fail to realise is that joining a Death in Service scheme can cause a loss of this protection. Considering the fact that many people are simply unaware that they even have Death in Service benefits, a simple act of changing jobs, for example, could result in a loss of their protection and as a consequence, their beneficiaries could face a substantial tax charge on the inherited pension pot.
Re-broking Death in Service Schemes: a potential poisoned chalice?
Another potential issue is again out of the individual’s control. Over the course of time, the cost of Death in Service schemes can increase and it’s often good practice for a broker to find alternative cover from another insurance provider if savings can be made.
For ease of administration, it is common for the broker to simply set up the policy using a new Trust obtained from the new insurance provider, adhering to the needs of the employer, but failing to take into account the needs of the individual members.
As a new trust has been used, however, it will be classed as a new scheme and Fixed Protection will be lost. If the broker had simply set up the new policy under the old Trust (which many providers are willing to do), it would be classed as a continuation of the old scheme and have no bearing on an individual’s protection.
The message is clear, individuals with large pension funds, high salaries and/or Fixed Protection need to be aware of the potential issues surrounding Death in Service. The potential tax charge of 55% on lump sum death benefits, not to mention immediate HMRC fines of £300 for failing to notify them of the loss of Fixed Protection, are too significant to ignore and anyone concerned about their own circumstances should consider seeking financial advice.
How Tilney can help
Tilney’s financial planners are experienced at helping people structure their finances and make complex financial decisions. We offer free initial telephone consultations as a way to discuss your specific circumstances with a financial planner. During this consultation, we can’t give you advice but we can provide guidance and, if you decide you would benefit from financial advice, we can explain the options and the costs. It’s easy to book online or give us a call on 020 7189 2400.
This article is based on our understanding of current legislation. Whether any tax will be payable and at what level it is charged depends upon individual circumstances and may be subject to change.
This article was previously published on Tilney prior to the launch of Evelyn Partners.