At risk: How pension tax reforms will affect group life

However, a bigger issue for employers with EGL policies rests with the exit and periodic inheritance tax charges that apply to discretionary trusts used to facilitate prompt payment, mirroring death benefit payments under registered pension arrangements.

The trusts governing non-pension schemes attract exit and periodic charges introduced to curtail the inappropriate use of trusts as vehicle for investments.

A charge would arise if an insurer settled a death claim from the trustees when the trust passed a ten-year anniversary but the trustees had not distributed the benefit to dependants.

Furthermore, we understand that HMRC considers that there is value in the trust if a member is terminally ill when the potential liability is assessed at the ten-year point.

This appears to mean that, for deaths between years ten and year eleven, trustees should check whether the member was terminally ill at the ten-year point.

This is despite one of the conditions for an EGL policy being that the policy proceeds can be paid only on death.

The potential payment arises only in connection with a terminally ill scheme member. It does not apply in other circumstances (for instance, where a scheme member dies in an accident).

In practice, trustees and the employer may be unaware that a member is terminally ill. It is doubtful, in practice, whether a GP would be prepared to confirm that to the trustees or to the employer after death.

As the sole asset of the trust is a life policy that pays on death only, the trustees cannot reasonably plan for the payment of tax. In practice, they will be unaware that there is a liability or the amount of it until a death claim is made.

Solutions

Now is the time for the industry to step up with practical and workable solutions. There can be little doubt that if tax relief changes place too big a burden on employers, they will use reduce or withdraw cover.

The review of pension tax incentives provides the opportunity to consider in more depth how death benefit provision by employers can be encouraged with a model that is sustainable and easy to understand.

We should also use the opportunity to press for death benefit provision through non-pension models to be put on a consistent footing with cover through registered arrangements where it is sensible to do so.

If employer contributions across pensions are incentivised at a flat rate, this could create a benefit-in-kind tax liability for higher earners, introducing a totally new level of complexity.

Members opting out could put at risk the inclusive basis on which schemes are priced.

Furthermore, most schemes are unit rated, and there is no individual age-related pricing on which a benefit in kind assessment could be made.

Applying the unit rate to assess a charge to tax could lead to an unfair distribution of tax charges. Allowing for new employees and for scheme leavers would complicate this further.

To put this into context, the average cost per member of lump sum death benefits across all death benefits written in registered schemes in 2014 was £125, less than £2.50 each week.

Removing the complexity surrounding the provision of cover under EGLs would be in the spirit of reform and create greater certainty for employers and trustees alike.

Although there are still almost 500,000 people covered for dependants' death-in-service pensions, the numbers are falling as employers close existing defined benefit arrangements or move to a lump-sum basis.

In practice, few beneficiaries are likely to be higher-rate tax payers when an income is paid, the average annual benefit in force at the end of 2014 being £10,509.

Consequently, the current tax treatment of contributions to fund the cover could continue as the market runs off.

Ron Wheatcroft is technical manager at Swiss Re