The current pension Lifetime Allowance is threatening to play havoc with group life assurance schemes – popular with many companies.
Employers need to be up to speed on the different types of schemes available and consider if their employees are in the right one.
Yet many are unaware of potential problems and the danger that arises when employees die prior to retirement.
The Lifetime Allowance is the total value of any benefits under pension legislation. Under HM Revenue & Customs rules a death benefit from a ‘registered’ group life assurance scheme counts towards this. If this benefit when added to pension funds exceed the limit for a particular tax year, it could result in a tax payment on the excess of up to 55 per cent.
The Lifetime Allowance was once as high as £1.8 million but is now just £1 million, increasing to £1.03 million in April 2018.
And while death-in-service benefits provided through a registered pension scheme have always formed part of the Lifetime Allowance, given most firms offer around four times your salary it has become a risk factor for more people now that the allowance has fallen
This has left thousands of middle managers and others vulnerable to being sucked into the tax net.
A mainstream example concerns someone earning £100,000 with death-in-service benefits worth four times their salary. If they die before retirement, the £400,000 payment would count towards their Lifetime Allowance, leaving a tax-free limit of just £630,000 after April 2018. Their heirs would pay tax on any benefit above the Lifetime Allowance.
So the chances of breaching the limit are real for many people – arguably another case of the law of unintended consequences coming into play.
This applies too with so-called ‘protection’.
Ongoing guidance by the Pensions Advisory Service states: “When the Lifetime Allowance was introduced in 2006 and in subsequent years when it has been reduced following pension reforms, those with benefits valued in excess of the Lifetime Allowance have been able to apply for ‘protection’ to protect the value of benefits they have built up (and future benefits that may accrue) from tax charges.”
However, if ‘protection’ is in place on an individual’s pension portfolio, being in a ‘registered’ group life assurance scheme can result in this being lost – for example if the person moves jobs and gets a new death-in-service benefits package viewed by the tax authorities as an addition to their pension fund.
Thankfully there are a number of ways to be more tax efficient in ensuring the death benefits left to your loved ones are not subject to unnecessary tax.
One is through taking up death-in-service benefits via an ‘excepted group life policy’.
Or you could ask your employer to help you fund a stand-alone life insurance policy rather than offering death-in-service benefits.
The advantage in providing life assurance cover under an ‘excepted’ scheme or a ‘single life relevant policy’ rather than under a ‘registered’ scheme is that the death benefit from these types of plans is not a reportable event to HMRC so do not count towards the Lifetime Allowance.
Single life relevant plans can also run alongside a ‘registered’ scheme sharing the same unit rate per £1,000 of cover and could have a free cover limit where no underwriting is required. It could also result in the premium being lower than if an individual policy is set up.
It is vital that employers and indeed employees take advice on the best way forward.
Employee benefit perks help attract quality staff and it is important to retain them.
No-one wants to pay more tax than is strictly necessary.