April’s £1m pensions lifetime allowance poses serious questions about the tax efficiency of group life arrangements for high earners. This year’s Budget could make the situation even more uncertain, finds Edmund Tirbutt
The failure of the Government to end the archaic link between pensions and life assurance means the group risk sector has become increasingly exposed by the gradual reduction of the pension lifetime allowance.
Introduced in 2006 at a level of £1.5m, the LTA had climbed to £1.8m by 2010 but has since gradually reduced to its current level of £1.25m, and is due to fall further to £1m in April.
This means that, having traditionally been viewed as affecting only the wealthy, it is becoming relevant to middle-management types who have built up sizeable pension pots over the years.
Canada Life Group Insurance marketing director Paul Avis says: “In 2006 the lifetime allowance affected only 3,000 individuals but it is widely estimated that this April’s reduction to £1m could affect an extra 300,000.”
Aon Employee Benefits head of broking and proposition for health and risk Matthew Lawrence says: “Although employers and individuals often consider the impact of the lifetime allowance from a pension savings perspective, it is important that the imp-lications for lump sum death-in-service benefits are not forgotten. This is because, by default, any lump sum death benefits payable from a registered arrangement would be the last benefit to be tested against an individual’s available lifetime allowance.
“In addition, other lump sum benefits payable on death, such as a return of contributions from a DB scheme or return of uncrystallised funds from a DC scheme before age 75, would also count towards the lifetime allowance. Because of the cumulative way in which the lifetime allowance is used up by any relevant benefits already taken, consideration of how lump sum death-in-service benefits are structured and provided may be necessary to reduce the possibility of a 55 per cent tax charge on any excess lump sum payable above the limit.”
In particular, there are a number of employers providing life cover at 10 times salary, meaning it would not take much to tip employees over the £1m limit.
Jelf Employee Benefits head of benefits strategy Steve Herbert says: “I’ve come across employees earning £75,000 on 10 times salary life cover, so they could have only £250,000 of pension assets without breaching the new limit. But their employer wasn’t aware until it was pointed out to them.”
Group risk impact
In the long run, the impact on the group risk community could be broad. Employers that have ceased pension contributions to employees who have obtained pension protection are typically increasing their salaries in lieu. This will raise IP cover limits – which are linked to salary – and could also result in employees using some of their additional cash to buy IP and critical illness cover via flex schemes.
But Unum head of proposition development Andrew Potterton says there is currently “only a
little bit going on” on both fronts and, while the LTA could increase in the future, its impact is not yet significant.
Arguably of more significance is the fact that the LTA iss-ue has stimulated benefit reviews that could boost demand for group risk schemes in future. Again, the impact so far has been limited, but JLT Employee Benefits head of group risk and healthcare Adrian Humphreys predicts that it will result in Swiss Re’s Group Watch figures showing a significant rise in the numbers covered by GIP in a couple of years’ time.
He says: “This has stirred up the mud and we are getting endless calls from companies starting to get clever about benefits. In the old days, people would call just to ask me to rebroke at a better price, but now they want to completely redesign their benefits. Every scheme I’m working on wants a tailored package.
“Why would a single person want four times salary life cover when they could have group inc-ome protection instead? Group income protection is the most undervalued cover out there and it’s far more valuable for young single people than life cover.”
Excepted life issue
The principal impact of the LTA reductions is translating to a shift in the direction of excep-ted schemes. Unlike registered schemes, these do not count towards the LTA. According to Swiss Re’s Group Watch 2015, in-force excepted schemes doubled in number from 1,974 in 2011 to 3,951 in 2014, and exc-epted group life premiums grew by 27.9 per cent in 2014. The trend is expected to continue.
Swiss Re technical manager Ron Wheatcroft says: “Research among the main market participants supports the view that we will see an increase in the number of in-force excepted group life and relevant life policies at the end of 2015, partly as a result of the reduction in the lifetime allowance to £1m from April 2016.”
If those who have to withdraw from registered group life schemes want to continue with group life cover, the excepted route is the only viable solution. Excepted schemes involve little difference in price and make administration only marginally more complex for insurers. Nevertheless, they involve a degree of risk.
The main issue concerns the possibility that HMRC will, in due course, regard taking out
excepted schemes as an act of tax avoidance. This could possibly result in the benefits being taxed at 55 per cent; or, some suggest, the premiums could become taxable as a benefit in kind in the hands of the employee.
Portus Consulting director of consulting David Dolding says: “The tax avoidance issue has been causing a few sleepless nights as it’s completely untested. There is no case law and HMRC has refused to clarify the situation.
“I think the reason why so many excepted schemes are being written is that people are weighing up the situation and deciding that this theoretical problem is the lesser of two evils when compared with the actual charge that can result from exceeding the lifetime allowance.”
Other much publicised risks associated with excepted schemes are of less significance. The discretionary trusts used for them enable benefits to be paid to beneficiaries free of inheritance tax but they are treated in a slightly different way from pension trusts.
Mercer partner John Matthews says: “The discretionary trusts are subject to periodic charges every 10 years but this really applies only if there is money in the trust on the tenth anniversary. If, for example, insurers have paid out to the trustees on someone’s death but the trustees haven’t yet forwarded the money to the beneficiary, there could be a charge, but the maximum you could pay is 6 per cent.
“The charge could also be triggered if someone in the policy becomes seriously ill because HMRC’s view is that the policy has a value because you could sell it.
“These scenarios probably won’t arise, but to mitigate the problems all you have to do is cancel the trust well before 10 years and start a new one. However, if the policy has a seriously ill person in it at the outset and death occurs, the trust would be subject to an exit charge, again up to a maximum of 6 per cent.”
Insurers, while continuing to monitor the situation and ack-nowledging that there are issues worth worrying about, are confident that it remains appropriate to continue to offer excepted schemes for the time being.
Ellipse CEO John Ritchie says: “Overall, I think the anxiety has been overdone and we should be focusing on the general efficiency of the package.”
But until HMRC provides more clarity on the subject, it is important that everyone keeps on their toes. In particular, it is not entirely clear whether intermediaries could be held liable for adv-ice given in relation to excepted schemes, so anyone advising in this area should ensure that they retain an audit trail to confirm they have explained the possibility of a backlash occurring.
All eyes on the Budget
Changes announced in the 2016 Budget on 16 March could see questions over the robustness of excepted life cover increased further.
It is not impossible that the LTA will be reduced further – the figure of £750,000 has been quoted in some media reports.
Alternatively, the LTA could become redundant if the Chancellor decides to radically alter the basis of pension taxation to an Isa-style regime, or to int-roduce an even lower annual allowance of £20,000 or £30,000.
But the common view is that this is becoming increasingly unlikely and that he will instead opt for a single rate of tax relief for all DC pensions, and possibly DB. However, the possibility remains of different rules for DB and DC.
A further possibility is that George Osborne will take on board feedback from the group risk industry and completely sever the link between pensions and life cover, meaning that excepted schemes have no adv-antage over registered ones.
Group Risk Development spokesperson Katharine Moxham says: “We have been seeking a break in the link between pensions and life assurance and communicated this in our response to last year’s consultation on pension tax relief. There’s no reason for the link – it’s just unintended consequences all the way.”