Although pension plans for the “still employed,” when they die to appear to be a good bargain, there are rules that cover payment of the lump sum offering. This is especially true when the beneficiary(ies) plan to receive four times the worker’s annual salary in payment upon death.
Courtesy of Royal London, a mutual insurer, rules indicate that an expected lump sum could actually be considered part of the employee’s lifetime allowance (LTA) of £1 million for the tax assessed on pension deposits.
Depending on the amount of the extra lump sum and the deceased worker’s accumulated pension savings, the total could go over the top. This would indicate that there would be a 55 percent to be assessment levy on the amount above £1 million. An unplanned for tax bill in the tens of thousands of pounds could be shocking.
While this potential difficulty applies only to a particular type of death-in-service provision, it is not always the case that pension product buyers are part of a written trust within the protection of an approved pension plan.
There are options. Royal London, for example, supports another set up for benefits, e.g. those who have an “excepted group life policy,” they say, are not taken up with the LTA problem.
However, the company cautions: “If Her Majesty’s Revenue and Customs (HMRC) think that this method has been used purely to avoid tax then they can levy a tax charge in any case.”
Reductions in the LTA have taken place over the years, starting in 2011/12 when it went down from £1.8 million in 2011/12 to £1.5 million and then £1.25 million. It ended up dropping to £1 million in 2016/17. Beginning in 2018, it will go up according to the rate of inflation. So, greater numbers of individuals and their heirs have been snagged by the tax snare.
Royal London’s, Steve Webb, director of policy, stated that ‘it is ridiculous to say that someone who has died has saved ‘too much’ into a pension because they were unfortunate enough to die prematurely.
‘In addition, the fact that some types of life cover count for tax and others apparently do not means that individuals do not know where they stand. The government needs to review these rules as a matter of urgency to end the distress being experienced by bereaved families.
‘It is also important that employers ensure that workers are told if this issue could apply to them, and that employees ask searching questions of their pension scheme.”
Webb recounted the story of a widow who wrote to him because her husband died of cancer. He was 51. Due to the death-in-service proceeds, his total pension held the £173,000 above the LTA threshold.
As she recounted in her letter, “the law was introduced to prevent very wealthy people from overfunding their pension plans. It seems very strange to me that I am being penalised for becoming a widow.”
Chase de Vere Financial planner, Pat Connolly, a financial planner had this to say: ‘It does seem unfair that certain workplace life assurance payouts are tax-free, whereas others are potentially liable to a LTA charge.
“The bottom line is that pension and tax rules are confusing, and so those with larger pension or investment assets and those being paid larger salaries should take the independent financial advice to ensure their finances are structured as tax efficiently as possible.
‘In regard to death-in-service payouts, using an independent financial adviser could mean that the lifetime allowance charge is reduced, avoided or planned for in advance, perhaps by using alternatives to pension savings or taking out a separate life assurance policy,” Connolly concluded.