Some families struggling to cope with the death of a loved one will be hit by a 55% tax on death-in-service payments intended to help support the surviving partner. Many workplace pension schemes include a death-in-service clause which , if an employee dies, will allow the surviving partner to take a lump sum. This can be up to four times the Deceased’s annual salary, ensuring that a large portion of their pension contributions go to their family. But those taking a lump sum could see it slashed by up to 55% under new rules.
The rules dictate that the death-in-service payment will count towards the Deceased’s pensions Lifetime Allowance – the £1 million limit on the amount you are permitted to save tax-efficiently into pension funds. Where the lump sum pushes the person over the permitted limit, their Personal Representatives will pay the 55% tax on the excess.
In effect, the rules impose a penalty on the Deceased as if they have saved too much towards pension schemes – despite the fact that the payout of the lump sum only results from their death.
It is thought that the tax would have made little impact when the Lifetime Allowance for pensions savings was £1.8 million in 2012 – but now it has been lowered to £1 million over the past four years, this could affect a lot more people.
The £1 million cap was introduced to dissuade the wealthy from overfunding their pension but the effect of including the death-in-service payment in the Lifetime Allowance is to penalise surviving spouses/civil partners. Whilst the resulting payment may seem generous, it may not be sufficient where the Deceased was the breadwinner in the family and the surviving partner has little or no income stream. They must invest the payment to give themselves and their family an income for life, and the slashed payment will make this more difficult.
Critics suggest the Lifetime Allowance should affect those who have contributed large amounts into their pension, rather than targeting families struggling to cope where someone is unfortunate enough to die prematurely.
Of note, some policies might not be affected by the rules. Experts believe that policies written into trust within an approved pension scheme will count towards the Lifetime Allowance – but those with life assurance benefits that arise from an “excepted group life policy” may not to be affected. However, there has been no test case for this and it is possible HMRC will apply the rules to both.
The tax, which was introduced in April 2016, is not the only measure that has affected grieving families in recent times – the Government already slashed bereavement benefits in the form of Widowed Parent’s Allowance and Bereavement Allowance in April.