Don’t unintentionally breach your Lifetime Allowance

Does your employer have a death in service scheme? If so, you could be at risk of unintentionally breaching your pension Lifetime Allowance. Read on to find out why.

The Lifetime Allowance is the maximum amount you can build up in your pensions before incurring tax – currently standing at £1.055m.

If you’ve had fixed or individual protection (or even primary and/or enhanced protection) in the past, you might have a higher Lifetime Allowance.

So, what happens if you breach the limit?

We think you’ve got the gist! Breaching the Lifetime Allowance will result in a tax charge of 55% (if you take the excess as a lump sum). If it’s left within the scheme to be taken as income, the charge is 25% with the income drawn taxed at your marginal rate. The tax charges are triggered when you draw pension benefits above your Lifetime Allowance, an automatic test will assess whether you’ve reached your maxiumum allowance either when you reach the age of 75 or if you pass away before this age.

Whatever your Lifetime Allowance, why might you breach it?

Many company group life assurance plans are classed as registered group life schemes (meaning they are written under pension scheme legislation). As a result, any lump sum benefits paid out by your company if death occurs whilst still in employment, could count towards your Lifetime Allowance.

If, for example, you earnt £100,000 and had death in service cover for four times your basic salary (£400,000), you’d be left with just £655,000 of your Lifetime Allowance remaining (if the standard allowance applies).

If you also had a pension scheme valued at £1m, the pension and death in service payout combined would take you over the standard allowance by £345,000. If this was being taxed at 55%, that’s an eye-watering £189,750 tax bill!

Even if you do have a form of protection, if the benefits within an existing death in service policy change (e.g. four times salary increases to five times salary), or you become a member of a new registered death in service scheme, the protection could be revoked, leaving you with a larger than expected tax bill!

How can you avoid being in this situation?

Care must be taken when changing employment – ensure you’re not joining a registered death in service scheme that will lead either to a loss of pension protection or to a possible Lifetime Allowance charge.

You could ask your employer or new employer to provide a death in service benefit through an “excepted group life policy” such as a relevant life policy – this way it doesn’t count towards your Lifetime Allowance.

There are other bonuses to having death benefits via a relevant life policy:

• premiums paid don’t use up your annual allowance so won’t revoke existing protection.
• premiums paid by the employer aren’t subject to income tax as they’re not normally assessed as a benefit in kind the employer benefits from corporation tax relief on the premiums as long as this can be demonstrated as qualifying for the ‘wholly and exclusively’ rules.
• the benefits payable aren’t subject to inheritance tax – as long as they are paid into trust.
• once you leave the company, you may have the ability to assign the policy to yourself personally – something not possible to do via the death in service policy through the pension scheme.

This is certainly an important area to consider – especially if you have both large pension benefits and a death in service policy through your employer.

If you’re in any doubt, check with your employer about the type of death in service policy you have in place to be sure you’re not in danger of exceeding the Lifetime Allowance or breaking existing protection.

If you have any concerns, please get in touch with your usual contact.