If you are not careful, you could help clients sleep walk into a cliché, and boy is it the naffest cliché in our industry;
“Nothing is certain but death and taxes,”
If you come across clients affected by the scenario I will be covering here, it’s quite a big deal. This is because the tax sums considered are potentially very large, as they are linked to pensions, and the impact will be felt after your client dies, so you could have irate relatives raising complaints against you following your client’s death.
We have seen a lot of recent cases where clients are near or have already passed the Lifetime Allowance limit, currently £1.055 million for 2019/20, and indexing with CPI each year.
The problem arises where a client has sizeable Death in Service benefits that are written under pension rules.
You see, a lot of employer’s company group life assurance plans are classed as registered group life schemes as a result of being written under pension schemes legislation. As a result of this, any lump sum benefits paid could be counted towards the member’s Lifetime Allowance if death occurs while they are still in employment.
When you think that Death in Service benefits could be written from, say, 2 times salary up to 8 times salary or more, there is a significant risk that such a payment will push a clients pension benefits over the LTA limit.
As a result, the fund could incur a tax charge at 55% if excess benefits are taken as a lump sum or 25% if the beneficiary takes the excess as income.
An additional complication that adds to this risk is where an individual member who may have a form of LTA protection (such as fixed protection 2016 at £1.25m) could have the protection revoked if they become a member of a new registered death in service scheme or if the benefits within an existing policy is altered. This could be something like two times salary increases to four times salary.
As the protection would be lost, this could result in an even larger tax bill on the member’s beneficiaries.
If you encounter scenarios like this, at the very least you should consider engaging the member with the problem to manage their expectations.
For you, there could be real opportunity to win brownie points too with effective planning.
Consider helping the client engage with their employer to change the basis of the death in service. The alternatives to Death in Service written under pension rules is to effect an ‘Excepted Group Life policy’, or to agree with an employer to set up a stand-alone life insurance policy, where the benefits on death would not be counted against the LTA test.
An excepted group life policy (EGLP), is subject to life insurance legislation not pensions legislation and so these life insurance benefits are not tested against the LTA.
They are, however, subject to more complicated inheritance tax rules which are applicable to discretionary trusts, and where the employee buys excepted group life insurance through salary sacrifice, the premium will be subject to income tax and National Insurance Contributions.
An EGLP is a policy that meets all seven of the following conditions:
1. It can only pay lump sum benefits for deaths before age 75.
2. Benefit must be worked out in the same way for everyone included in the EGLP.
3. If the EGLP is cancelled, it must not have a cash value. However, unused premiums can be refunded.
4. Only the benefits set out in the EGLP can be paid.
5. Benefits can only be paid to: (i) Individuals (ii) Charities (iii) Trusts set up for individuals.
6. Benefit cannot be paid to another person also covered by the EGLP. However, benefit can be paid if that other insured person is a dependant or relative of the person who died.
7. The EGLP must not be set up with the main purpose of avoiding tax.
The most common EGLP covering one person is often called a relevant life policy.
There are also differences in the tax regime for employees and for self-employed equity partners/LLP members where benefits are payable under a Discretionary Trust.
In summary, clients in this position where their Death in Service benefits would push them over the LTA limits should clarify with their employer as to which type of Death in Service plan is in place and if there is any flexibility to change the scheme to an EGLP or a stand-alone individual life plan. At the very least, advisers should ensure that their clients are aware of the implications that Death in Service benefits under pension rules can have on their Lifetime Allowance.
With careful involvement, you can help the client unravel a potentially expensive structure to one that removes the tax risk, justifying your fee for some considerable time and engendering added client loyalty.