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Death in Service – Beware Hidden Tax Charges

As financial planners one of the first subjects we explore with clients is whether they have enough protection – Life Assurance, Critical Illness and Income Protection or sick pay. Arguably the most important topic of discussion is – what would happen if things went wrong? Would your family cope financially?

Death in Service – Beware Hidden Tax Charges
Daniel Boden

Daniel Boden

Chartered Financial Planner and Partner

A cornerstone of many client’s protection portfolio is their employee benefits package. Along with sick pay, death in service is perhaps the most common employee benefit and pays a lump sum if an employee dies whilst working for the company. Death in service benefit is expressed as a multiple of salary so pays out a lump sum of (usually) 3 to 5 times salary.

Different types of death in service

Group Life Assurance scheme

The most common type of death in service is a scheme set up under a discretionary trust. The company covers the cost of the premiums and the benefit is not classed as a benefit-in-kind for employees.
The trustees have the final say on who the benefit is paid to so its important for employees to nominate the beneficiary they wish to receive the cash. Importantly, the benefit is paid out tax-free.

Pension based scheme

Sometimes, death in service benefit is linked to a company’s pension scheme and can be only open to ‘active members’ – employees who contribute to the pension.
The death in service amount is usually expressed the same as the other life assurance scheme -  as a multiple of salary – but it’s how the pay-out reaches the employee’s family where the important difference lies. If the pay out is made into the pension scheme, then there could be a significant tax charge to pay before the cash reaches the beneficiaries.

What is the tax charge?

Payment of the benefit into the deceased’s pension fund could trigger a lifetime allowance tax charge with high earners and those who’ve built up large pension pots being particularly at risk.
With the Lifetime Allowance currently standing at £1,055,000 it’s easy to see how this amount could be breached.

For example:

  • An employee on a salary of £150,000 entitled to a death in service benefit of 5 times salary could get £750,000 paid into their pension before it’s paid out to beneficiaries.

  • If they have built up a pension of say £500,000 then a tax charge of 55% on the excess would be payable. This issue is of course amplified for those with higher salaries.

  • £750,000 + £500,000 = £1,250,000

  • £1,250,000 - £1,055,000 = £195,000 excess @ 55% = £107,250 tax charge.

In this scenario the beneficiaries would get £1,142,750, which could be less than anticipated and may present the family with a shortfall.

In short a proportion of the financial safety net set aside for loved ones could end up being retained by HMRC.

Relevant Life Insurance

Unlike a group death-in-service insurance scheme, a relevant life policy is deemed to be ‘non-registered’ which is important as any claim paid out does not count towards an employee’s pension. This can provide an alternative for some who may be impacted by the Lifetime Allowance.

What should you do?

  1. Check with HR how your death in service benefits would be paid to you

  2. Ensure you have completed a nomination of beneficiaries form to ensure your death in service benefits are paid to whomever you wish

  3. Review your protection portfolio to ensure you and your family are adequately covered if the worst were to happen.

To discuss your family protection needs, contact us

 

This article is distributed for information purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Ermin Fosse and does not represent a recommendation of any particular security, strategy or investment product. The information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
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