Providing death benefits to higher earners

Out-Law Guide | 07 Feb 2020 | 2:36 pm | 1 min. read

Providing death benefits through a registered pension scheme may have adverse tax consequences where the deceased is a higher earner.

Certain lump sums paid out on the death of a scheme member are tested against the deceased member's lifetime allowance. A tax charge is payable if the allowance is exceeded. In addition, those individuals who have preserved a higher than standard lifetime allowance through enhanced or fixed protection may lose that valuable protection if death benefits are provided for them through a registered pension scheme.

The lifetime allowance is £1,055,000 for tax year 2019/20. Employers should review the way that death benefits such as death in service lump sum cover is provided, particularly for higher earners.

Triggering of the lifetime allowance charge

Certain events trigger a test against the lifetime allowance of a member of a registered pension scheme. Those events include the payment of a lump sum on the death of a member under age 75 if, broadly, they have not yet taken any benefits from the relevant pension arrangement.

It is relatively easy to set up an excepted group life scheme, although certain points need to be handled carefully to ensure there are no unintended tax consequences.

Any employee whose death in service lump sum might take them over the lifetime allowance is affected, particularly high earners with death benefits based on a high multiple of salary.

Bear in mind that the employee may already have used up some of their lifetime allowance before death - for example, by drawing income from a separate defined contribution pension pot.

Loss of enhanced and fixed protection

Enhanced protection and fixed protection allow certain higher earners to continue to benefit from the higher levels of lifetime allowance that were available in the past. The provision of a death benefit from a registered pension scheme will usually lead to that protection being lost.

There is an exception where the death benefit takes the form of a defined benefit (DB) promise that was made before the protection took effect – for example, the employee still has life cover under a closed DB scheme.

Changes to death benefits, or the provision of a death benefit for a new employee, will generally lead to any protection being lost.

Moving employees to an excepted group life scheme

One potential solution to these tax issues is an excepted group life scheme. A group life scheme is an arrangement for providing the whole workforce or a group of employees with lump sums on death in service.

The advantage of this sort of scheme is that it falls outside the lifetime allowance regime, which applies only to registered pension schemes. In addition, excepted group life schemes are not subject to the registration and reporting requirements that apply to registered pension schemes.

It is relatively easy to set up an excepted group life scheme, although certain points need to be handled carefully to ensure there are no unintended tax consequences.