One of the less well-known threats from the current inflation shock is its likely impact on the Lifetime Allowance (LTA).
Pay packets are expected to grow as demand for increases surge in response to rising prices. However, the LTA is being reduced in real terms. In fact it has been slashed from £1.8 million in 2011/12 to just under £1.1 million now.
It is also set to be frozen at this level until the 2025/26 tax year, no matter what inflation does – and don’t forget it was linked to inflation until the 2021/22 tax year.
As a result, an increasing number of employees face the possibility of being dragged into this tax trap that can disincentivise people to remain in work and prompt considerations of early retirement or tapering down hours and days at work.
The well-publicised stories emerging from the NHS reveal the damage that the allowance thresholds can have when it comes to retaining these more experienced workers with bigger pension accruals and contributions
This issue is often focused on employers or sectors that provide more generous defined benefit pensions to their workforce, but it isn’t just the NHS or even defined benefit pension members who are affected by this. Many employees who have income around the £100,000 mark and have contributed or invested well within defined contribution schemes are also being affected as the LTA is reduced.
This means that we are not just talking about a select group or the super-rich who may start to see their pension savings creeping up to the LTA threshold with additional pay-rises, but those who have ‘done well’ for themselves
More and more public sector workers banking on their trade-off of lower salaries for bigger pensions or those who have committed to a long career with a company that offers a ‘good’ pension scheme as a key employee reward could experience issues.
It creates a dilemma for employers who must look to protect their workers’ benefits, whilst maintaining their own financial security, not to mention the possibility of a ‘silver brain drain’. Just over the past three years, the employment rate of people aged between 50 and 64 years has shifted abruptly into reverse, declining by 1.8 percentage points from 72.5 per cent in 2019 to 70.7 per cent in 2022
These factors all lie behind a growing awareness and demand from employers and pension scheme trustees to explore the use of Excepted Group Life Trusts (EGLT).
The reason for this of course is that the LTA includes Registered Group Life in trust too. So, if you earn £80,000 pa and have £600,000 in pension savings with 6 times salary on death, your total assessed for LTA is £1.08m – over the limit.
EGLTs sit outside of an individual’s LTA assessment and consequently can provide lump sum death benefits that don’t count towards an individual’s lifetime allowance total. This would effectively mean in the above example only £600,000 would be accumulated against the LTA, resulting in no tax charge.
So, for some employees with larger pension savings, it would not require a noticeably big death benefit from a registered pension plan to tip them over the LTA. But EGLTs can protect workers from this risk. It gives workers the chance to continue working and building up later-life savings to enjoy a long, comfortable retirement without the fear of breaching the LTA.
But excepted schemes are not a panacea – either for employers or employees. Businesses need to take steps to protect themselves as well as their employees to implement these effectively.
As an example, what is not always highlighted is that EGLTs are subject to IHT rules which means they could fall foul of entry, periodic and exit charges if the trust holds “relevant property” when the trust is established or when it reaches a 10-year anniversary.
Employers could therefore face unexpected costs to mitigate these risks, including winding up and replacing the trust before it reaches a 10-year anniversary, ideally in the 8th year of the trust. Advice should also be sought as if this isn’t done correctly the Trust could suffer an unexpected tax charge.
So, with increasing salaries, pension benefits, a decreasing LTA and many original excepted life policies coming to their 8-year anniversaries now is a key time for businesses to start considering whether an EGLT might support their workforce, or if their existing EGLT is still fit for purpose.