Many employers have a death in service scheme in place as a way of enhancing the benefits package on offer to their employees. However such schemes are often put in place and left to gather dust in the hope that they are never called upon. Helen Trethewey looks at why employers should review these schemes and what alternative arrangements may be more beneficial.
Typically, the benefit involves a multiple of the employee’s salary or other fixed sum being paid to family members or nominated beneficiaries on the employee’s untimely death. For employees, the scheme provides reassurance that their family or other nominated beneficiaries will receive an immediate financial cushion on their death; for employers it is a way to provide a universal and popular benefit that is tax-efficient and supports an employee’s loved ones at a difficult time.
It is highly likely that, if you, as an employer have not reviewed your death in service arrangements in the last few years, you may be inadvertently creating tax consequences for your higher paid employees and such benefits could prove to be more of a hindrance than a help.
Why might your death in service scheme no longer be appropriate?
In recent years the Lifetime Allowance (LTA), against which certain benefits are tested, has reduced from £1.8m in 2010 to £1.0m in 2016/17. The LTA is the threshold within which pension benefits can be accrued by an individual within UK registered pension schemes without tax being payable. To the extent a member exceeds the LTA when pension savings are drawn (for example retirement or death), a tax charge of up to 55% will be payable.
We increasingly see that employers are further enhancing the multiples of salary for employees either as an additional benefit or as compensation for the loss of dependant's pension as the cost of providing these increases.
The reduction in the LTA now gives rise to a greater risk that automatically signing up certain employees to workplace schemes will detrimentally impact their pension pots:
If there is a chance that any of your employees may have claimed LTA protection (such as Fixed Protection and Enhanced Protection) to safeguard the pension benefits they have already built up then there is a risk it can be lost automatically if the employee joins a registered scheme. This protection could be claimed when the LTA was introduced in 2010 and each time it was reduced so it is possible that this protection could be lost when individuals are automatically signed up to a death-in-service scheme on joining a new employer.
Any payment paid out under a registered death-in-service scheme will be tested against the LTA so there is a risk for employees who are higher earners and benefitting from several multiples of salary that this could significantly impact their LTA.
The alternative?....Excepted Group Life Schemes
Employers may wish to consider Excepted Group Life Schemes for employees because:
- it means that a lump sum benefit paid on an employee’s death falls outside of the LTA
- they retain any previous protection claimed.
For high earners who may be key individuals within the business are able to continue to benefit from a death in service arrangement without the additional tax liability that it may bring.
However, an EGLS will need to meet conditions set out by HMRC to enable them to benefit from this particular treatment so particular attention must be paid to how such a scheme is set up.
How can we set one up?
Employers can arrange for a group life policy that meets the EGLS conditions which would then be held via a discretionary trust and scheme rules. The employer would normally be the trustee of such a trust although this is not always the case. Under the rules any death benefit can be paid out to the member’s family or nominated beneficiaries. A lump sum can pass outside the member’s estate, avoiding inheritance tax.
No registration with HMRC is necessary in the case of an EGLS. Where an employer only wants to provide cover for one key employee outside of a registered pension scheme (an exceptional earner, individuals with protection or those looking for higher multiples), this can be achieved with a “relevant life policy”. Relevant life policies are subject to similar conditions as an EGLP scheme but are limited to a single member.
You should ensure that you are aware of the taxation position with EGLSs as it will be necessary to manage certain risks. It is also crucial to review and monitor EGLSs rather than leaving them to gather dust following implementation.
How can we help?
With employers likely to come under pressure to be providing tax efficient benefits to their staff and with the LTA unlikely to be raised other than to reflect inflation, EGLSs are likely to be increasingly attractive.
We recommend all employers review their existing and potentially outdated death in service arrangements. We can:
- advise on the suitability of the arrangements;
- review any policy documentation provided by the life company; and
- review the trust deeds to ensure that your schemes, whatever type, are fit for purpose.