A major drawback of registered group life schemes is that, due to an archaic link with pensions, the lump sum proceeds count towards the pension Lifetime Allowance (currently £1.073 million.)
So, there is a real risk that a death-in-service pay-out will trigger a 55% tax charge on the excess amount if an employee has built up substantial pension assets.
Similarly, even if their pension pot contains only a few hundred thousand pounds, the charge could still be triggered if they have high levels of life cover – and we have certainly come across employers providing 10 times salary.
Furthermore, the Lifetime Allowance is most unlikely to be increasing by anything more than an adjustment for inflation for the foreseeable future.
Introduced in 2006 at a level of £1.5 million, it had climbed to £1.8 million by 2010, before beginning a gradual downward descent. Indeed, with the Government desperate to balance the books in the wake of the coronavirus crisis, it could even fall further.
So, although originally viewed merely as a problem affecting the wealthy, this issue has become increasingly relevant even to middle-management types.
But alternative forms of life cover do provide a solution. Excepted group life schemes and relevant life insurance (their equivalent for individual policies) are set up in unregistered schemes – meaning that they are not subject to the Lifetime Allowance.
Whilst we are finding larger firms are starting to show increasing interest in excepted group life schemes, relevant life policies are still all-too-often going below the radar.
Many companies are therefore missing out on what can be a particularly useful tool for protecting key individuals and topping up existing group life cover entitlements.
Relevant life premiums are paid for by the employer, but the employee is the life insured. The policy must be written into a discretionary trust (for which the employer is the settlor and trustee, and the employee is the trustee and beneficiary) and the proceeds cannot benefit the company. They are paid into the trust for the potential benefit of the employee, if they become terminally ill, or of their family, should they die.
Because the benefit is written in trust for the employee, it is not taxed as a business asset. The employer doesn’t pay any tax or National Insurance (NI) and can usually claim tax relief – without even referring to HMRC.
Employees do not incur a P11D liability and there is no Inheritance Tax payable by their estate in the event of death, or other tax penalties if they receive the pay-out in the form of terminal illness benefit.
The tax treatment of premiums, and the fact that premiums can be paid by the employer, as opposed to being paid from personal taxed earnings, means that it is a very tax efficient way of arranging life insurance.
It should be noted that, as with excepted group life schemes, relevant life policies do have the potential to incur ‘periodic and exit charges’ of up to 6%. In practice, however, these are fairly unlikely to arise and the former are easy enough to mitigate – by cancelling the trust well before its 10-year anniversary and starting another one.
The slight risk of incurring such charges should be considered in the context of the Lifetime Allowance issue and of the other significant savings that can be realised by these tax-efficient policies.
Content correct at the time of writing and is intended for general information only and should not be construed as advice.