Ron Wheatcroft reveals the wider implications of pension tax reforms on later life income and in particular employers' death-in-service cover
The pension tax reform consultation issued by HM Treasury (HMT) on 8 July last year has very wide implications on the way in which later life income is generated, and the tax incentives used to do so.
The government clearly wants good use of tax revenues to incentivise behaviour. The present system is complex and tax poorly understood.
Death benefits
Although the consultation asks a number of very specific questions, one area not included is the provision of lump sum and dependants' pension death-in-service benefits through registered pension arrangements.
The government needs to be cautious about the unintended consequences upon such arrangements.
This is because the group death benefits employers offer can be registered as an ‘occupational pension scheme' under the Finance Act 2004, with the same tax reliefs available to retirement benefits.
Employers play an active role in the provision of death benefits for their workforce, but doing so is entirely voluntary.
Consequently, employers can withdraw or reduce them, subject only to any need to consult with employees where entitlement is written into their contract of employment.
The group life market provides 40% of all insured benefits held in the UK, so there is a lot at stake.
Inclusive cover
Most schemes are entirely employer funded, are inclusive of the whole workforce, and are simple to understand.
Changes that make provision more costly and complex could mean that employers opt for alternatives.
This, in turn, might mean that lower earners and people in poor health find that they and their families are left with no cover at all, resulting in greater dependency on state benefits.
We do not believe that the HMT review is intended to drive change in the way that employers provide death-in-service cover, and that it is very open to proposals that minimise the impact and allow the market to operate efficiently.
Market size
Most employers insure the liability to pay a claim on death under a group death-in-service policy, although some very large employers choose to self-insure the risk.
It is common for such employers and their advisers to test the market periodically. Most policies have no exclusions: payment can be made quickly at a time when it is most needed.
The majority of lump-sum death benefits are insured in registered arrangements, and are therefore very much within the scope of the consultation.
At the end of 2014, 7,765,281 people were members of 41,323 insured lump-sum death benefit schemes, and 494,870 were members of 3,294 insured dependants' death-in-service benefit schemes (Source: Group Watch 2015, Swiss Re).
The number of members of dependants' death-in-service arrangements is reducing as the cost of annuity benefit provision has increased in the low interest rate environment.
Current tax treatment
Employer premiums for their employees' cover can be offset against profits for tax purposes. Premiums are not treated as a ‘benefit in kind' for employees.
Lump-sum death benefits are paid tax-free to dependants using a discretionary trust, subject to the Lifetime Allowance, taking account of other benefits held in registered pension arrangements.
Dependants' pensions are taxed as income in the hands of the recipient, in the same way that a retirement pension is taxed. They do not count towards the Lifetime Allowance of the deceased.
Unlike a retirement pension, however, there is no tax-free cash element. Dependants' pension cover remains a valuable insurance for final salary schemes promising a lifetime annuity on the death of an employee.
Non-pension death benefit arrangements
In addition to the number of people and schemes shown above, there were 3,951 Excepted Group Life (EGL) policies in place at the end of 2014, covering 391,438 people.
EGLs are non-pension arrangements which have enjoyed the same tax treatment of premiums as registered group life since 2006.
Although numbers are growing, fewer than 5% of employees enjoying lump-sum life assurance through the workplace do so under an EGL policy. EGL policies can provide a helpful facility where an individual has fixed or enhanced protection.
Legislative restrictions on the extent of coverage and complicated tax rules, which mean that there can be an unexpected tax charge depending on the cause and timing of death, mean that relatively few employers choose EGL policies.
Some employers have set up multiple policies - sometimes ten or more - to overcome these issues which, at outset, are mainly due to the need to apply a common benefit formula across all scheme members. It is not clear what potential leakage of tax this is meant to address: no such restriction applies to registered pension schemes.
