Employees with generous death-in-service lump-sum benefits may find themselves bitten after April 2016 when the new lifetime allowance rules kick in.
According to Iain Laws, managing director for healthcare and risk at national advisory firm Jelf Employee Benefits, the majority of employers – and their employees – are unaware that death-in-service lump-sum benefits could push pension savers over the LTA limit.
Research from Jelf Employee Benefits’ 2015/2016 survey found that 78 per cent of employers are unaware that death-in-service lump-sum benefits can contribute to a pension LTA.
At its peak in 2010, the LTA was £1.8m, but successive budgets under chancellor George Osborne have seen the LTA reduced to £1.25m. By April 2016, it will reduce to £1m.
|LTA: a brief history|
2012/13 and 2013/14: £1.50m
2014/15 and 2015/16: £1.25m
Mr Laws said: “On the face of it, this may appear to have nothing to do with benefits other than pensions, but this overlooks the reality that benefits payable under a Group Death in Service scheme can often count towards the lifetime maximum.
“This hidden connection to the world of pension savings may start to bite after April 2016. Lump-sum payments for higher-paid employees are often now set at multiples of four, eight or even 10 times salary. It is likely that some such payments will, by themselves, use up most or all of the Lifetime Allowance limit in the event of a member’s death.”
In a worst case scenario, if a family breadwinner dies, and their dependent chooses to take the pension as a lump-sum benefit, the death-in-service payment can absorb most of the LTA, with the remaining amount being returned to the deceased’s family after a significant reduction in taxation.
Mr Laws added: “The ongoing reductions in LTA mean it’s essential that employers at least inform their employees of the rules and examine the suitability of the available plan designs to mitigate the application of LTA, and at best provide employees with access to guidance to help understand their individual situation.”
Michael Brooke, financial planner for Cheshire-based Clarion Wealth Planning, wrote in a client newsletter: “In some cases, it may make sense to continue contributing and to pay the additional tax charge on any excess. For funds extracted as income that charge currently stands at 25 per cent, plus the scheme member’s marginal rate of income tax on the residue after deduction of this charge. The LTA charge is 55 per cent if excess funds are taken as a lump sum.
“Employees who benefit from generous employer contributions may, if the option is available to them, choose to stop making personal contributions, but decide it makes sense to continue receiving their employer’s contributions whatever the tax that may eventually be levied upon this.
“When funding above the LTA with personal contributions, a key element of the calculation is the differential between the member’s tax rate at the time of the contribution and at the time that income is taken. If income in retirement can be maintained at a level that does not incur higher-rate tax then, based on the current pensions tax relief regime and rates of income tax, funding above the LTA could sometimes make sense.”