Emma Lunn

Grieving families face unexpected tax bills

Little-known rules regarding ‘death-in-service’ payouts from workplace pension schemes could see grieving families hit by shock five-figure tax bills.

That’s according to Royal London which says millions of employees are at risk of exceeding the pension lifetime allowance because of their death-in-service benefits. As a result, it’s calling for a change in the rules.

Many company pension schemes offer workers’ families a lump sum ‘death-in-service’ payment of up to four times the employee’s annual salary if they die while employed by the firm.

But a little-known caveat of this payment is that it can count against the £1 million lifetime allowance limit for tax-relieved pension contributions.

For example, say you earn £100,000 and have death-in-service benefits worth four times your salary. If you die before you stop working, the £400,000 payment would count towards your lifetime allowance. If you already had more than £600,000 in your pension pot, your heirs would end up paying tax of 55 per cent on the excess.

In some cases, this will generate an unexpected tax bill running into tens of thousands of pounds, leaving your family a lot less money than expected.

Royal London has found this problem has become more acute since the lifetime allowance was reduced from £1.25 million to £1 million in April 2016. In 2010 the allowance stood at £1.8 million but has been reduced steadily since then, due to a number of pension reforms.

The lifetime allowance will be frozen at £1 million until 2018 and then rise in line with inflation. This means that, as earnings grow, more and more people will potentially be dragged into the tax trap – so it’s not simply an issue for the super-rich.

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