Death-in-service: Inheritance tax & Budget impacts

life assurance, life policies, master trust, The Pensions Regulator, trusteeship, Vidett

Rachel Reeves’ Autumn Budget has aimed to “make the inheritance tax system fairer” by making changes to death-in-service rules and inheritance tax, such as adding tax to unspent pension pots. Will death-in-service payments paid via discretionary trusts be affected when the changes go into effect on 6 April 2027? How will you be affected? We don’t know everything yet, but we can dive deeper…

Pensions, inheritance tax and death-in-service

The Budget speech revealed plans to “[bring] inherited pensions into inheritance tax from April 2027”, announcing that unused pension funds and death benefits will now be considered part of a person’s estate. The rights and wrongs of this remain in debate, but what do they have to do with death-in-service benefits?

Most companies offering death-in-service benefits to employees insure the potential lump sum due (typically a multiple of the salary). In the unfortunate event an eligible employee dies, the insured amount is usually paid out through a “registered group life scheme,” – a discretionary trust set up solely to provide death benefits. These are considered pension schemes by HMRC, subjecting them to pension tax rules.

Death lump-sum payments from a discretionary trust (where the schemes trustees decide who receives the paid-out death lump sum) are not currently counted as part of the deceased employee’s estate are therefore not subject to inheritance tax. It’s unclear whether the government intends to change the inheritance tax position of payments from these types of group life schemes.

The impact of pension and inheritance tax changes on group life schemes

Although the speech didn’t say much, on the day of the Budget, HMRC opened a “technical consultation” seeking views on the processes required to implement the proposed changes,focussing on the increased role for pension scheme administrators who will become liable for reporting and paying any inheritance tax due on unused pension funds and death benefits.

However, it’s only reference to group life policies/schemes was hidden in an appendix setting out that “All life policy products purchased with pension funds or alongside them as part of a pension package offered by an employer are not in scope of the changes”. This can be read as confirmation insured death-in-service benefits will not be impacted. However, the undefined meaning of “pension package” prevents confirmation. In the past it was common for death in service benefits to have been provided by a defined benefit (DB) pension scheme but with the closure of many of these schemes, a lot of death-in-service cover is now provided via a separate trust set up specifically to provide insured death lump-sums. Does that count as part of an employer’s “pensions package”?

A written question on the changes was submitted to the House of Commons, where James Murray, Exchequer Secretary to the Treasury responded:

Most unused pension funds and death benefits will be considered part of a person’s estate, meaning it is liable for the inheritance tax.
The likelihood of being taxed depends on the scheme. Group Life insurance schemes (where the funds are held in trusts), are not considered part of the estate and therefore dodge the tax. Other schemes, like DB pay death in service as a lump sum, therefore are part of the persons estate and liable to tax.
There will be more consistence in how death-in-service benefits are treated, regardless of the type of scheme.

This appears to support the view that insured death-in-service payments payable from group life schemes will not fall within the scope of the intended changes, but it could be more definitive.

What are excepted life policies and how do they fit in?

Some companies provide death-in-service benefits to employees via an “excepted group life scheme”. This is a discretionary trust, like a registered group life scheme, but falls under specific trust tax rules rather than pensions tax rules. They’re typically used to cover death-in-service benefits for employees potentially impacted by certain pension limits.

Payments from these schemes currently fall outside of the deceased’s estate and are not subject to inheritance tax, but it’s unclear if they will be impacted by the proposed changes.

What if my death-in-service arrangement is impacted?

If a death-in-service payment forms part of a deceased employee’s estate, it could reduce the payment amount the beneficiaries receive (i.e inheritance tax), compared to if it had not been included in the estate.

Also, the government’s proposal is that the scheme administrators will become liable for reporting and paying any inheritance tax due: meaning the administrator must wait for the deceased’s personal representative to confirm if the estate is subject to inheritance tax or not and, if so, what proportion of the nil rate band(s) should apply to the payment due.

Currently, if the deceased affairs are fairly straightforward, there is no personal representative and payments are made fairly quickly. If group life schemes are in the proposed changes, appointing a personal representative and gathering the necessary information could elongate the process resulting in a payment delay; potentially increasing distress levels in an already difficult time.

What should I do if my company’s death-in-service arrangements are impacted?

Until there’s some clarity, it’s best to patiently wait. We’ll be responding to the consultation to seek clarity on these points. However, if it eventually becomes clear that payments from your group life scheme will form part of the deceased’s estate you may wish to:

Consider if alternative structures for your death-in-service benefits are more appropriate.
Make employees aware of the changes – it could impact their thoughts on who they nominate any payment to go to.
Review the administrative process and communications for dealing with death cases which are likely to become more complex.
Make sure the trustee(s) of your group life scheme are aware of the changes and the additional administration required to deduct and pay the correct tax.

At Vidett, we offer both a group life and excepted life master trust, through which employers can pay death-in-service benefits, ensuring death in service cases are handled by experienced, independent professionals.

For more information on any of the above, please contact client director Shaun Kilcoyne from our Life Assurance Trustee Services team.