Death in service benefits provide employees with a multiplier of their annual salary in a lump sum. This sum is usually held within a trust structure and is not accumulated with the value of an employee’s estate (property, money and possessions) for the calculation of inheritance tax.
As well as being the case for many employees in the private sector, this is also true for members of our Armed Forces. The MoD published guidance regarding the Armed Forces Pension Scheme (AFPS 15) in May 2023 which states:
“In the event of your death, your eligible dependants – spouse, civil partner, eligible partner or eligible children – will receive benefits. These may consist of a one-off lump sum (tax-free) and a taxable pension.”
And goes on to say:
“If you die in Service, your spouse, civil partner, or eligible partner will receive an immediate pension paid for life and a tax-free lump sum. The lump sum is four times your final pensionable earnings and will be paid regardless of whether you have completed at least two years of qualifying service.”
The advantages of a death in service benefit are twofold. Firstly, a cash injection following the untimely death of a working age family member, perhaps the primary income earner, is a financial lifeline for families. Secondly, this is usually a tax free lump sum which does not get tied up in the estate administration process. It is paid directly to the eligible dependants of the deceased employee and is generally available much more quickly than other assets which require a Grant of Representation before being released.
The changes to the taxation of pensions in the recent budget, understandably caused consternation across both professional advisers and the general public. Headlines announcing a 65% tax rate were numerous and it is true that the general changes are likely to cause examples of double taxation to a pot which we have all been encouraged to prioritise when dealing with our own personal finances.
Within the wider pension changes a smaller, more insidious change, has been made specifically to the death in service benefits for members of our Armed Forces. If a member of our Armed Forces dies ‘on duty’ their dependants will continue to receive their death in service benefit free of inheritance tax. However, if a member dies ’off duty’ their dependants may have to pay as much as 40% inheritance tax on the lump sum.
MP Mark Francois, shadow minister for defence, provided a case study evidencing the cost to members of our Armed Forces who die ‘off duty’:
A senior warrant officer at the top of the non-commissioned officer rank structure, has a partner to whom they are unmarried, and on death leaves an estate worth £400,000 and death-in-service benefits of £248,292—four times their £62,000 salary. They would pay 40% inheritance tax on the non-pensioned assets, resulting in an IHT liability of £30,000, but after April 2027, and if the death-in-service benefits are included in the estate, that will increase the estate’s value to £648,292, and the IHT liability will increase accordingly to £129,316. That represents a staggering increase of 330%.
Whilst the loss in value to members of our Armed Forces is concerning enough, there is also the administrative burden to be considered. Indeed, in a briefing on the topic, the Forces Pension Society explained:
At a time of extreme vulnerability, these lump sums need to be paid promptly, as they currently are. If death in service benefits become subject to IHT there will be a delay to the benefit being paid both while the estate is assessed for IHT and while the amount of IHT attributable to the DIS [death in service] benefit is assessed and the scheme administrator (Veterans UK) pays the tax charge.
It is disturbing that a distinction has been made between ‘on duty’ and ‘off duty’ personnel. There are not many members of our Armed Forces who change who they intrinsically are, just because they are not ‘on duty’. How many times have we heard stories about ‘off duty’ members of our Armed Forces running directly into danger or emergency situations to save the lives of others. Additionally, just by being a serving member of our Armed Forces they put themselves at risk of retaliatory and terror attacks. No one has forgotten the brutal murder of off duty Fusilier Lee Rigby. Should the death benefit paid to his bereaved family have depended on whether he was on or off duty at the time of the attack?
Focusing solely on the death in service benefits of those members of our Armed Forces who die ‘off duty’ causes unwarranted harm to a very small section of our society. The taxation of death in service benefits across the private sector and for those ‘on duty’ will remain unchanged. The government is yet to set out their reasoning for the change and many hope that it was an unintentional result of the general pension changes, however, there have been no steps to correct the error if this is indeed the case.
Whilst the number of bereaved families caught in the new regime is likely to be small, we have to ask whether this is just the start of further changes to death in service benefits. The huge changes to inheritance tax in the recent budget were largely unexpected, particularly with regard to the capping of inheritance tax reliefs set to severely affect farmers and entrepreneurs. Throughout the next five years should we all prepare to lose the dual benefit that a death in service lump sum provides?
For members of our Armed Forces, there are two action points to consider. Firstly, take professional advice as to the potential tax liability on your death and the administrative delay before your family have access to funds. Secondly, if you think that a delay or reduction in lump sum will adversely affect your family, consider taking out a separate life insurance policy which will pay your family an immediate tax free lump sum.
If you need assistance with inheritance tax planning or organising your estate, get in touch with our expert Private Client solicitors by email or call +44(0)3333 231580.