Jonathan Watts-Lay, Director, WEALTH at work, a leading financial wellbeing and retirement specialist, comments; “Death in service benefit is generally paid as a tax free lump sum, calculated as a multiple of the employee’s salary. Employees can nominate who they would like to receive this lump sum in the event they die whilst employed at the company. It is usually paid free of income tax and inheritance tax to the employee’s nominated beneficiaries.
However, most employers death in service arrangements are set up under pension legislation, meaning it can form part of the employee’s lifetime allowance (LTA) when it is paid. In certain cases, this could lead to a 55% tax charge on some, or all, of the death in service benefit.
With the LTA now fixed at £1.073m until April 2026 many members of workplace pensions may be nearer than they think to the LTA. Upon death before retirement, the death in service payment would be added to this value and any excess above the LTA would be taxed at an eye-watering 55%. For example, a pension scheme valued at £800,000, and a death in service plan (through the employer’s pension scheme) at 4 times salary on £100,000, the death in service payment of £400,000 would be added to the existing pension value of £800,000, giving a total of £1,200,000. This employee is now over the LTA by £126,900 resulting in a tax charge of £69,795 (@55%).
Some employers choose to offer an ‘excepted group life policy’ to employees impacted by the LTA. This would mean their death in service benefit would be paid outside pension legislation and would not incur an LTA charge.