I came across a sad yet topical story featured in the Daily Telegraph last week which focuses on the problems caused when a person’s Pension Pot and Death in Service benefits exceed the Lifetime Allowance….a message which we are driving very hard at the moment and story’s like this really help support the reasons why Relevant Life Cover can often provide a better outcome for clients in this position.
Telegraph article 9 NOVEMBER 2016 • 10:37AM
The life insurance bungle that cost us £80,000 in tax when my Stephen Seabury’s family was left with a huge tax bill because of how his late wife’s employer paid a lump sum
Sarah Seabury did everything right. Over 30 years working as a management consultant she made good use of generous pensions allowances and built up savings worth £933,000.
But she was diagnosed with cancer and, after a two-and-a-half-year battle, died in late 2014 at the age of 54, leaving a husband, Stephen, and a teenage son and daughter.
The family were well prepared and had set up a trust to hold Mrs Seabury’s unused pension pot and the “death in service” payment paid by her firm.
Her pension was well below the lifetime limit, which at the time was £1.25m, but the family was shocked when three separate letters addressed to Mr Seabury and the two children arrived – demanding that they pay a total of £78,650 in tax within 30 days.
They had expected to pay no tax at all – death in service payments are tax free, as are pension funds passed on when someone dies under the age of 75.
The problem was that Mrs Seabury’s employer, like thousands of others, offered the death in service benefit under a pension arrangement – meaning it was counted as a pension contribution like any other.
Will your death push you over the pension lifetime allowance?
As a result her £933,000 “defined contribution” pot became £1.39m – her family was paid a typical lump sum of four times her salary – so she breached the £1.25m lifetime allowance.
“It left a sour taste in the mouth,” said Mr Seabury, who later discovered that his late wife’s employer offered other staff another way to pay death in service benefits that keeps the funds outside the pension. This would have saved nearly £80,000 in unnecessary tax.
He said: “Some people say ‘be grateful she had accumulated such a large pension fund’ but that’s because she saved hard and we didn’t spend the money.
It left a sour taste in the mouth
“I was annoyed that her employer hadn’t said anything to us because Sarah had cancer for two-and-a-half years. She was only away when having chemotherapy, she was there and talking to people in the firm. It would have been really nice if someone in the HR department had said ‘let’s move you into the newer scheme’, but nobody did.
“It wasn’t the greatest of feelings – I really want people to understand that this can happen to them too.”
Employers often offer “death benefits” through pension schemes to cut their and their employee’s tax bill.
But Jackie Holmes of Willis Towers Watson, the consultancy, warned that more people would be caught out. The lifetime allowance was cut to £1m in April and Mrs Holmes said death in service payments were becoming more generous – multiples of up to 10 times salary were now common, she said.
So was there anything the Seaburys could have done to keep more out of the hands of the taxman?
When the lifetime cap on pensions was introduced in 2006 the government offered “protection” that insulated savings already built up.
New tranches of protection have been launched as the allowance has fallen since, meaning previous years’ higher caps can still apply. Each series has a different set of horrendously complicated rules – a financial adviser can help navigate them.
However, once protection is in place, any new pension contributions can void it, warned Alistair Cunningham of the financial adviser Wingate Financial Planning. He added that people might also lose protection if they moved jobs and the new employer used a scheme like Mrs Seabury’s.
Mr Seabury warned that other families could be caught out
He said that while in some cases protection could be applied for after death, this could only be before the lump sum was paid.
It might also have been possible to cut the level of the tax charge. HMRC takes 55pc of anything above the lifetime allowance if the money is taken as a lump sum, or 25pc if withdrawn as regular income. Some schemes will also pay a “dependants’ pension”, although this would be subject to income tax.
Because of the risk of more people being caught out, firms are increasingly using alternative methods to pay out death in service benefits, Mrs Holmes said.
“Excepted” group life policies ensure that these kinds of life insurance payment do not count towards the pension allowance. But employers are being cautious: if HMRC deems that the arrangements are being set up to dodge tax it may well step in.
Your pension pot is tested against the lifetime allowance when it is “crystallised”. Events that count as crystallisation include death, savings being accessed, transfers to an overseas pension scheme and reaching age 75.
Kate Smith of Aegon, the pension company, said: “Potentially this is an increasing problem if the employee hadn’t taken action before death, because of the reduction in the standard lifetime allowance.
“People need to remember to include death in service benefits when checking against the lifetime allowance. Ideally they should get individual advice. Those affected can apply for ‘fixed’ or ‘individual’ protection and make sure their employer’s death in service benefit is outside the pension scheme.”
Of course, you can also set up your own life insurance arrangements but – unlike with death in service payments – you will have to pay the premiums yourself.