With most of the UK’s working population employed rather than self-employed, the tax changes announced in the 2024 Autumn Budget regarding pensions have caused concern - especially for those who have diligently built-up substantial pension savings. But what do they mean for death in service benefits (DISB) provided by employers from 2027?
The current rules
A DISB is a payment, typically a multiple of gross salary, paid to a nominated beneficiary or family member if the employee dies while employed. It may be offered by employers as part of an employee's benefits package, and is frequently linked to pension arrangements. Traditionally, these schemes were set up under discretionary trusts, meaning the benefit would be held in such trust and would not form part of the employee’s estate for inheritance tax (IHT) purposes. The trustees of that trust would then have discretion over who receives the payment, guided by the employee’s nomination. Where the nominated party was a spouse (for example), this option could often provide a useful IHT shelter.
The changes
From 6 April 2027, undrawn pension funds and certain DISBs will be brought into an individual’s estate for IHT purposes, regardless of whether they are held in a discretionary trust.
The Government’s rationale is to encourage genuine retirement saving and to prevent pensions being used primarily as tax planning tools. This announcement initially sparked concern that DISBs linked to pension arrangements (which are often a generous feature of employer benefit packages) may also become subject to IHT.
Thankfully, the Government has now provided clarity. Despite the wider changes to the taxation of pension funds and death benefits, DISBs from registered pension schemes will remain outside the scope of IHT, irrespective of whether the scheme is discretionary or non-discretionary.
The intention behind this exclusion is to avoid incentivising employers to use alternative, non-pension trust structures for DISBs, which could have led to inconsistencies with public sector defined benefit schemes, where payments are funded by the Exchequer.
While the upcoming changes to the taxation of pension funds may affect many individuals, those with DISBs from registered pension schemes can breathe a sigh of relief. These benefits will continue to be protected from IHT, thus preserving their value for beneficiaries and maintaining consistency across both private and public sector arrangements.
Your employee benefits and pension arrangements should be reviewed to ensure they remain fit for purpose in light of evolving tax rules.