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Five points to know about the ‘Death in Service’ benefit

Paloma Kubiak
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Paloma Kubiak

No-one likes to think about their own mortality but as an employee, you may be eligible for ‘Death in Service’ benefit. Here are five important points to know about this scheme.

Death in Service is one benefit which may be offered by companies to employees. Staff typically need to pass their probation period to be eligible, and if employed at the time of death, a lump sum is paid out to beneficiaries.

When you are setting up this kind of documents whether is a death in service or a will you need to be very careful because there are a few aspects that can turn it into an invalid will, that is why is so important to do it with a professional.

Below, we look at five important points to note about Death in Service:

1) You don’t need to die while at work

While ‘Death in Service’ sounds like you need to pass away while at work or involved in a task directly relating to your job, that’s not the case. Death can occur at any time; the only real requisite is that you’re an employee of the company and are on the payroll. You should check your company’s policy schedule though, as cover may be altered during illness, injury or extended leave.

Shaun Robson, head of wealth planning at Killik & Co, says: “Remember that if an employee leaves the company where Death in Service (DIS) is offered, they will no longer be covered so they should check with their new employer if they offer a similar benefit.”

2) What does it cover?

While the employer pays the premiums, the employee’s family are the ones who benefit from it. It typically covers two to four times the employee’s annual salary if you’re employed at the time of your death, Robson explains.

But Gary Smith, director of financial planning at Tilney, says it’s important to look at the definition of the scheme rules.

He says: “It’s commonplace for DIS to be 4x salary in the private sector while those who work for the NHS and teachers typically get a 2x multiple. You can have different levels in the same scheme such as for managers or junior staff members.

“But you need to look at the definition of the scheme rules to find out what it covers. If it covers salary only and you earn a £10,000 salary and £90,000 in dividends, then the definition of 4x salary is only £40,000 of life cover, not £400,000. The scheme must say if dividends are included and check if it covers additional earnings, basic salary or if there is no additional remuneration.”

3) Tax-free and quicker pay out

Jonathan Watts-Lay, director of WEALTH at work, says DIS benefit is generally paid as a tax-free lump sum. “It is usually paid free of income tax and inheritance tax to the employee’s nominated beneficiaries”, he says.

After death occurs, there’s typically no inheritance tax for the employee’s family to pay on the benefit because the money goes into a trust rather than straight into their estate, Robson explains.

“The trustees then pay the money out to the employee’s family meaning they receive the full benefit”, he says.

He adds: “Whilst the employee’s wider estate may be caught up in the slow process of probate – the DIS benefit can be distributed by the Trustees without delay meaning the family have access to funds.”

4) Name a beneficiary

Ordinarily, a DIS scheme is set up under a trust, meaning trustees – i.e. your company – will have the final say as to who receives the money, Robson says. But employees can usually nominate who they would like to receive the lump sum by completing a beneficiary nomination form.

Smith says it’s important to fill out the nomination form as it “takes out the stress in an already upsetting time.” If there is no name on the DIS, trustees will ask for a copy of the will to see where assets should go. “If there’s no will in place, then the rules of intestacy are followed”, he adds.

5) Is it written under a pension rule or an exempt scheme?

While the DIS payment is usually paid out free of income tax and inheritance tax, there may be a tax charge on the sum. This is because of the pension lifetime allowance (LTA) – the maximum amount of pension savings you can build up without a tax charge – which is currently set at £1.073m until April 2026.

Most DIS schemes are set up under pension legislation, meaning it can form part of the employee’s LTA when it is paid, according to Watts-Lay. This could result in a 55% tax charge on some or all of the benefit.

He says: “Many members of workplace pensions may be nearer than they think to the LTA. Upon death before retirement, the DIS payment would be added to this value and any excess above the LTA would be taxed at an eye-watering 55%.

“For example, a pension scheme valued at £800,000, and a death in service plan (through the employer’s pension scheme) at 4x salary on £100,000, the death in service payment of £400,000 would be added to the existing pension value of £800,000, giving a total of £1.2m.  This employee is now over the LTA by £126,900 resulting in a tax charge of £69,795.”

However, he adds that some employers choose to offer an ‘excepted group life policy’ to employees impacted by the LTA. “This would mean their death in service benefit would be paid outside pension legislation and would not incur an LTA charge”, he says.

Data from AON published in June 2019 revealed that up to 67% of employers haven’t considered the impact of lump sum DIS benefits on the LTA of their employees.

However, Smith adds that DIS is renewed on an annual basis so at the point of renewal, “it could flip into an exempt scheme”.

“Most people won’t be aware that it’s written under a pension rule. Even if you have no pension, it may be written under a pension scheme. You don’t even need to be a member of a pension”, he warns.

And finally…

While DIS is a valuable benefit for employees, particularly where they may be in ill health or have a prohibitive condition so finding insurance elsewhere is expensive, Smith warns that people shouldn’t rely on it.

“If you’re married or in a couple and your partner dies, will the lump sum be enough to cover your mortgage, childcare, expenditure etc? It’s a great benefit but if you were to receive a £50,000 payout in your 30s or 40s, you still have 25 years to get to state pension age without a second income.”

Smith suggests employees look at additional cover privately, and it doesn’t have to include a lump sum as policies can pay out on a monthly basis.