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Death lump sum payout from pension could leave loved ones with huge tax bill

Written by: Paloma Kubiak
Complex and unfair rules regarding ‘death-in-service’ payouts from workplace pensions mean grieving families face huge tax bills when the money exceeds a current allowance cap.

Many pension schemes covering millions of workers offer a lump sum ‘death-in-service’ payment if a scheme member dies. This is typically around four times the annual salary.

But this payment counts towards the pension member’s Lifetime Allowance (LTA) – the maximum amount of pension savings you can build up without a tax charge over the course of your life.

The LTA currently stands at £1m (until 2018 before rising in line with inflation) and if the lifetime pension savings of the deceased person, plus the value of the death-in-service lump sum, exceeds this amount a 55% income tax charge is due.

This means some grieving families will face an unexpected tax bill running into tens of thousands of pounds. And mutual insurer Royal London said that as earnings grow, more and more people will potentially be dragged into a tax trap which isn’t just an issue for the super-rich.

Penalised for being a widow

A letter sent to Royal London’s director of policy, Steve Webb, showed the extent of the problem. Mrs B, wrote:

“I am a 59-year-old widow. My husband died aged 51. He was diagnosed with cancer and was dead within 12 weeks. The week before his death our adviser ascertained from his employer that the death-in-service benefit should form part of his LTA. This was a complete shock to us. As a result the benefit I received amounts to nearly 60% of his LTA. The monies received plus the payouts from the various pension plans have resulted in just under £173K overshoot on the LTA.

“The law was introduced to prevent very wealthy people from over-funding their pension plans. It seems very strange to me that I am being penalised for becoming a widow. While the payments may seem large when lumped together they need to be invested wisely to ensure I have an income for the rest of my life and to potentially cover the costs of any care I may need later in life. It seems manifestly unfair that I and I’m sure others are treated in this way.”

As such, Royal London is calling for a change in the rules so that bereaved families don’t have to deal with an unexpected tax shock.

Webb, said: “It is hard enough dealing with the loss of a loved one without having to face a huge tax bill as well.

“It is ridiculous to say that someone who has died has saved ‘too much’ into a pension because they were unfortunate enough to die prematurely.

“The Government needs to review these rules as a matter of urgency to end the distress being experienced by bereaved families.  It is also important that employers ensure that workers are told if this issue could apply to them, and that employees ask searching questions of their pension scheme.”

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