Breaching the LTA – the need for good advice
Danielle Byrne, technical consultant at AJ Bell, addresses the risk of breaching the LTA because of a death in service policy
I suspect when most individuals think of death in service policies their first thought isn’t the lifetime allowance. But maybe it should be?
Where a death in service policy is written under pensions legislation, lump sums paid out upon death count towards the lifetime allowance, potentially along with other pension savings. This can be a problem for the beneficiaries of high earners, who might have looked at the value of the deceased’s more traditional pension benefits and not realised they could face substantial tax charges.
The problem is created by the type of death in service policy; either group life assurance or excepted group life.
The relevant variance in terms of the lifetime allowance is that group life assurance policies are written under pensions legislation and a lump sum paid to the beneficiary would be tested against the lifetime allowance. The same type of lump sum paid from an excepted group life policy would not be tested against the lifetime allowance as it isn’t part of a pension scheme. Potentially the difference between incurring a hefty tax charge or not.
The lifetime allowance has been cut three times since 2010 and in spite of the inflation indexation which has now kicked in, more people are finding themselves closer to the lifetime allowance than ever. In particular this is becoming an issue for more senior public sector workers, for example head teachers, who may have final salary schemes.
Instead of providing financial security for loved ones, the fact that the death in service policy is written under a pension could take away a large chunk of the money the beneficiary would have received had the benefit been structured differently.
As an example, Petra has a pension scheme valued at £1m and a death in service policy at four times her annual salary of £100,000. Upon Petra’s death before retirement, the death in service policy would pay £400,000, which would be added to her existing pension scheme value of £1m, totalling £1.4m. This means Petra is over the current standard LTA by £345,000 and this excess will be taxed at 55%. Depending on how HMRC calculate the tax charge, it could be as high as £189,750.
Issues after death aren’t the only factors to consider where death in service policies are concerned. An individual who has either fixed or enhanced protection could see this revoked if they’re treated as setting up a new registered death in service arrangement or if their benefits within an existing policy change – e.g. the benefit changes from three times salary to four times salary. This could result in an even larger tax bill if the protection they thought they held no longer applies.
Unless we see lifetime allowance increases which go above and beyond the current inflation-based rises and communication improves surrounding pension-based death in service policies between employers and their employees, many individuals could unknowingly face significant tax charges just because of the structure of their death in service benefits.
Many advisers will be aware of the potential pitfalls and can advise accordingly but sadly this won’t assist those individuals and employers who don’t benefit from good advice.
Death in service is a valuable employee benefit aimed at helping loved ones in difficult times but care needs to be taken to ensure those same loved ones don’t end up with an unwanted tax bill.