Believe it or not, many employees are at the risk of unwittingly breaching their pension lifetime allowance (LTA) because of their death in service policy.
As you know, the LTA is the maximum an individual can save in their pension scheme(s) tax efficiently. As this was written, the limit was £1.03m. However, following the Autumn Budget announcement, this is due to increase to £1.055m from 5 April 2019 (subject to Finance Act approval).
There may be individuals who will have a higher LTA through previous rounds of fixed or individual protection (or even through primary and/or enhanced protection). In any case, everyone will have their own LTA.
Breaching one’s LTA will result in a tax charge of 55% if the excess above the LTA is taken as a lump sum. If it is left within the scheme to be taken as income, the tax charge is 25%, while any income drawn is taxed at their marginal rate. This tax is triggered when an individual draws pension benefits above their LTA, but can also be triggered as a result of the age 75 test or on uncrystallised funds if death occurs before age 75.
Many company group life assurance plans are classed as registered group life schemes as a result of being written under pension schemes legislation. As a result of this, any lump sum benefits paid could be counted towards their LTA if death occurs while they are still in employment.
For example, for a plan that provides death in service cover of four times basic salary, if an employee subject to the standard LTA earns £100,000, the policy will pay £400,000 on death in employment – leaving just £630,000 of their LTA remaining. If the member’s combined pension and death in service values exceed their LTA value, this could lead to beneficiaries facing tax charges and receiving less than they thought they would get.
Further, say an individual has their LTA at £1.03m, a pension scheme valued at £1m, and a death in service policy (through an employer’s pension scheme) at four times salary on £100,000. Upon death before retirement, the death in service policy would pay £400,000, which would be added to their existing pension scheme value of £1,000,000, giving a total of £1,400,000. This individual is now over their LTA by £370,000 – if this was being taxed at 55%, that’s an eye-watering £203,500 tax bill!
Furthermore, an individual who may have a form of protection (such as fixed protection 2016 at £1.25m) could have their protection revoked if they become a member of a new registered death in service scheme or if their benefits within an existing policy changes – e.g. four times salary increases to five times salary. This could result in an even larger tax bill if the protection they thought they had no longer applies.
So, what can be done? Well, care must be taken when individuals, change employment to ensure they are not joining a registered death in service scheme that will lead either to a loss of pension protection or to a possible LTA charge. One way this can be avoided is by asking the employer or the new employer to provide a death in service benefit through an “excepted group life policy” such as a relevant life policy (RLP), so that it does not count towards a LTA.
Additional benefits of having death benefits via the RLP include:
- any premiums paid not forming part of the employee’s annual allowance, so will therefore not revoke their protection
- premiums paid by the employer not being subject to income tax as they are not normally assessable on the employee as a benefit in kind
- the employer benefiting from corporation tax relief as long as this can be demonstrated as qualifying for the ‘wholly and exclusively’ rules
- the benefits payable not being subject to inheritance tax – as long as they are payable into trust
Also, the amount of cover an employee can receive is typically 20 or 25 times their salary and/or regular dividends, but this can vary per provider. Therefore, the death benefit payable could actually be higher in some cases. It is important to note, however – this type of cover is not a replacement for key person insurance or shareholder protection.
Plus, a key RLP benefit is that once the employee leaves the company, they may have the ability to reassign the RLP to themselves personally – something not possible to do via the death in service policy through the pension scheme.
This is certainly an important area to consider and especially for those individuals who have both large pension benefits and a death in service policy through their employment.
At the very least, employees should check with their employers about the type of death in service policy they have as it is important to check they are not in danger of exceeding their LTA, or breaking their protection. If an employee is concerned about their LTA, they should certainly get in touch to discuss the options available to them.