Many employer pension schemes now include a Death in Service benefit. But should the worst happen, this apparent perk may cause even more grief for your family if you don’t plan ahead. What are the risks and how can you avoid them? Article by Armstrong Watson Financial Planning.
Isn’t it ironic, as Alanis Morissette once sang? Your employer, keen to offer you a competitive pension scheme, includes a valuable benefit designed to take care of your family if you should die while in that employment. But due to intricacies of pension law, there are circumstances in which much of this benefit may end up being lost in tax. When might this happen – and what can you do to prevent it?
A quick word about Death in Service benefits
More and more employers are providing additional benefits to their employees as a means of attracting and retaining staff. Following the introduction of auto-enrolment in 2012, millions more people are now enrolled into workplace pension schemes, as the law now requires. However, many employers go beyond the minimum requirements and provide additional benefits as part of their workplace pension scheme.
One of the more common staff benefits is Death in Service, whereby an employer provides life cover for their employee during their period of employment. Death in Service doesn’t have to be provided alongside a pension scheme, but it often is; and it means that if you die while in the employment of that employer, a lump sum payment will be paid out to your family or nominated beneficiaries.
Now, here comes the crucial detail. Where a Death in Service benefit is linked to the pension scheme, the value of the lump sum payment made on your death will be considered as counting towards your total pension benefits.
So why is that a problem, you may ask? It’s a problem because of the pension Lifetime Allowance.
Your pension Lifetime Allowance
The government has set a limit on how much any individual can save into pensions over their whole lifetime, without triggering an additional tax charge. This is the Lifetime Allowance (LA), and applies to all your pension pots combined (including the value of any final salary schemes you may have, which involves a separate calculation). The LA has been falling in recent years, and currently stands at £1 million.
If you exceed the LA (whether knowingly or accidentally), any benefits taken from the excess will be subject to a hefty tax charge: 55 per cent if taken as a lump sum, or 25 per cent if taken as regular income. This is in addition to any income tax that might also be payable on the money.
The accidental overflow
Staying within the LA might sound like a simple task. But the problems can arise if there is a single unplanned windfall into the pension – for instance, a Death in Service payout. Such a substantial sum could well tip a large pension pot over the limit, resulting in a sizeable tax bill for the beneficiaries of the pension.
Fortunately, there are various ways you can avoid falling into this trap, if you think the total of your pension pots are close enough to the LA. Transitional arrangements have been put in place for those with pension funds close to £1 million who still want to accrue benefits (whether into a pension pot or in a defined benefit scheme). However, strict rules govern the options available.
One option is to ensure that your Death in Service cover is not linked to a pension scheme. You may instead be able to have it set up via a group life assurance arrangement, and this method would mean that LA limits will not apply.
Think about your protection arrangements
You may be among those fortunate to receive cover from your employer – but it’s wise not to depend too heavily on employers for your protection needs. Will your next employer’s benefit be as generous? What if you need another form of protection that your workplace arrangements do not cover? And what if you were to lose your job? This is why it’s important to make your own arrangements for family protection separately, so they are independent of your employment. Your own financial adviser can help you work out what you need and find the most suitable products for you.
If you think you and your family could possibly be affected by the issue surrounding Death in Service benefits and the Lifetime Allowance, first check with your employer to see what benefits are in place and how they are constructed, so you can determine whether changes may be necessary. Then you should consult an independent financial adviser to ask about a solution.
Armstrong Watson Financial Planning is a firm of independent financial advisers based at multiple office locations across the North of England and Scotland. Find your nearest Armstrong Watson office:
