A relevant life?

Even if pensions are not your forte, there cannot be any advisers unaware of the fundamental ‘simplification’ changes brought about from A-Day in April 2006. However, unless the adviser was involved in the group risk market they may not have been aware of some of the changes that affected death in service benefits.

Prior to A-Day, approved death in service provided up to four times salary at death plus a widow’s pension, but for post 1989 employees this salary was subject to the earnings cap. If you wanted to provide higher benefits then you needed an unapproved scheme but the cost of this would be taxed as a P11D on the employee.

Since A-Day these rules have changed. Approved schemes have become registered schemes, the cap has gone and there is no longer a limit to the level of cover. One might think therefore, there is no need for any other type of arrangement. However, with a registered scheme any lump sum payments on death will form part of the lifetime pension allowance (currently £1.75 million), with any excess being taxed at 55%. So for high earners these death benefits could have a nasty sting in their tail.

There is however a solution to this, in the form of the post A-day equivalent of unapproved benefits. These are non-registered schemes and are referred to under the legislation as ‘Relevant Life Policies’ (RLPs). Unlike their predecessor, they have a much more generous tax treatment:

Premiums are not taxed on the employee as a P11D

• Premiums can be offset as a business expense as long as the local inspector of taxes accepts they are made ‘wholly and exclusively for the purpose of trade’.
• Benefits paid through a discretionary trust are paid free of income tax.
• Benefits are normally paid free of inheritance tax, (although periodic and exit charges can arise in exceptional circumstances).
• Premiums do not count towards the annual pension allowance.
• Benefits do not form part of the lifetime pension allowance.

So any high earning client with substantial pension funds might well be advised to opt out of the registered group scheme and go for a Relevant Life policy, especially if they have taken pension protection.

Another useful factor is that RLPs can be written on a single life basis unlike registered group life benefits that cannot be written on a single life basis. And in any event most group providers are reluctant to go below five lives. This can be a problem for small limited companies, with perhaps only one or two directors. Many of these directors will have personal life cover which they will pay from post tax income, or if the company is paying premiums, the director will be taxed on them for both income tax and national insurance purposes.

A single life Relevant Life policy can be the solution to this. The company simply takes the policy out under a discretionary trust. The company pays the premium and the trust is set up with a range of potential dependant/family beneficiaries. While benefits are payable at the discretion of the trustees a nomination form can be used to guide the trustees, in their decision.

A quick look at the tax situation will show how effective this can be. The following table (below) assumes a 40% taxpayer, a 21% corporation tax paying company and a premium of £1,000. It shows the gross cost to the company for providing personal life cover; this cost can be offset against corporation tax as salary bringing the net cost down to £1,510.

By using a single life RLP there is no P11D charge so the gross cost to the employer remains at £1,000, saving approximately one third of the costs. If the local inspector accepts that the cover is wholly and exclusively for the purpose of trade, this drops the net cost down to £790 – a very useful saving of nearly 48%.

Single life Relevant Life plans are suitable for any employee of any type of business. However, they are not appropriate for equity partners or sole traders.

Benefits are paid free of income tax, and generally free of inheritance tax. One note of warning on this. Group risk practitioners will be aware that under a registered scheme as long as benefits are paid out within two years of death there is no liability to inheritance tax (IHT).

Relevant Life policies are however non-registered, so come under the normal discretionary trust tax regime. This means that there is the remote possibility that periodic and exit charges could arise if there were funds in the trust at a 10-year anniversary. This is only likely to happen if death occurred just before one of these anniversaries and there was no time for the trustees to pay the money out. The periodic charge would be at 6% of the value in the trust.

One of the advantages of an individual trust is the flexibility it can give on leaving the company. The trustees can appoint benefits back to the employee and they can then keep the policy as a personal one, even placing it under a personal trust. If they move employers, providing the new employer is willing to accept the plan then a simple change of trustees and the plan can move to the new company. This is particularly useful for small businesses which might be re-structuring or merging with other companies.

There is no statutory limit to the amount of benefit that can be provided, but providers will set their own limits. There are however some restrictions on the form of the policy laid down in the legislation. These are:

• Benefits are payable as a lump sum, no dependant’s pension can be provided.
• Only life cover can be provided, no other benefits can be included.
• Benefits must cease at age 75.
• There can be no significant surrender value
• Benefits must be payable to an individual or a charity, and as indicated above this can be through a trust. Most providers will probably insist on there being a trust set up
• The main purpose of the policy must not be tax avoidance. Assuming the policy is set up for the benefit of genuine dependant or family beneficiaries this is unlikely to be a problem.

Another use of the Relevant Life policy is topping up scheme benefits where the existing scheme rules are too restrictive. There is no reason why the RLP cannot live alongside the existing registered scheme. For instance the present scheme may not include bonuses and commission as part of pensionable earnings, or may have an upper cap on earnings.

Single life Relevant Life policies are not designed as a replacement to registered group life schemes. In most cases a registered group scheme will be more appropriate where there are sufficient lives to warrant one, as single premium costing will normally be cheaper, and free life cover is a valuable benefit. In addition, the trust arrangement does not have any potential periodic or exit charges.

However, for high earners, small companies with too few employees and where scheme top ups are required, the single life Relevant Life policy can be a very useful tool. 

Jerry Bayman is national partnership manager at Bright Grey