One of the key benefits of choosing to work for an employer, apart from the obvious salary incentive, is becoming part of their employer group life scheme (sometimes referred to as death-in-service benefit). However, because of an easily avoidable technicality, your heirs may have to foot an unexpected tax bill.
How to protect your heirs from excessive taxation
Group life cover is designed to provide a lump sum benefit to an employee’s family and/or dependants in the event of the employee’s death whilst they are in employment with the company. This is normally calculated upwards of four-times your basic salary, however, it can easily be more depending on the type of policy taken out by your employer.
One of the relatively unknown concerns with this type of cover is how the scheme has been set up. An employer has the option of setting up a registered or expected scheme. Currently, many UK businesses have chosen to set up a registered scheme due to its administration flexibility. Whilst at first glance this decision doesn’t set off many alarm bells, upon deeper investigation, it should.
Under current legislation, by default, any lump sum death-in-service benefit payable from a registered arrangement would be the last benefit to be tested against an employee’s remaining lifetime allowance.
With the current lifetime allowance limit currently sitting at £1 million, many employees may find their current pension pots and current death-in-service benefits exceeding this amount. Due to the cumulative way in which the lifetime allowance is used up by benefits already taken, and how a death-in-service benefit is structured, this could create a tax liability of 55% on any excess lump sum payable above the current limit.
This starts to become a real issue for employees in the 55-65 age group, as this is when important decisions are being made regarding accessing their pensions or taking their 25% tax free cash lump sum. Should part or all of a pension be crystallised, this will immediately reduce the lifetime allowance limit.
Let’s consider the fictitious John. He currently has a pension valued at £1.5 million and has decided to take his 25% tax free cash lump sum. This immediately reduces his lifetime allowance by £375,000 to £625,000. He also has a registered group life policy valued at £900,000. Should he now pass away and a successful claim be made by his beneficiaries, £275,000 of the benefit will now be taxed at 55%, as this exceeds his lifetime allowance.
Should you be on an expected scheme?
An expected scheme (or a relevant life policy for the smaller businesses) does not count towards an employee’s lifetime allowance. Expected schemes involve little difference in price and create marginally more administration. Therefore, this structure could be more appropriate for businesses.
However, this type of scheme does come with conditions:
- All members must have the same benefit calculation
- Benefit can only be paid to an employee’s relation, dependant or charity
- The 10 year anniversary charge (should there be a benefit payable but yet to be distributed by the trustees) could create a tax charge of up to 6%
Finally, this type of policy must not be taken out to avoid paying tax. However, currently there is no case law to test this rule, and questions will remain unanswered in this regard.
As a result of the above concerns I would recommend that any employer looking to set up a group life scheme, or any employee who is currently part of a group life scheme, should review the insurers policy documents to understand what type of scheme they have.
What to do if you’re concerned about your lifetime allowance
Should you find yourself in breach of, or concerned about, your lifetime allowance, there are options available to you. One option is to discuss your concerns with your HR department and work together to identify a suitable solution. Another option is to consider adding additional life cover to protect against this potential shortfall in benefit.
Financially protecting your family and loved ones from premature loss of life remains an important part of a financial plan. However, ensuring this cover is not impacted by a technicality is just as important.
I would advise to get in touch with a qualified financial adviser to discuss which is most suitable to you and/or your business. Give us a call on +44 (0) 20 7759 7519 or send an email to firstname.lastname@example.org.
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