Group life schemes: some “taxing” issues for employers but help is out there!

The type of policies vary and are typically split between UK “tax registered pension policies” and “excepted policies”. It is also possible to have “individual non-registered policies” called “relevant life policies”, which are essentially mini excepted policies for single members.

The main difference between non-registered and registered policies is that registered policies are classified for tax purposes as registered pension schemes. They are as a result subject to the same fiscal tax constraints as registered pension schemes. Benefits paid to beneficiaries under these registered schemes are generally free of income tax for most people – provided that the amount of lump sum benefit is within the Lump Sum and Death Benefit Allowance (which is currently £1,073,100 for most people) and subject to certain age restrictions at the date of death. Where these conditions are not met the recipient of the lump sum will be liable for income tax on the lump sum. Checking scheme documentation will be key here and a lot of employers may have lost their copy trust deed and rules.

From 6 April 2027, the Government has made changes so that unused pension pots and associated death benefits will form part of the deceased’s estate for inheritance tax calculation purposes – so these amounts will be classed as assets of the estate even if they were said to be gifted to a beneficiary in trust at the point of the member’s death. It remains unclear whether the IHT tax risks for unused pensions pots will apply also in respect of registered life assurance schemes set up under their own trust documentation, whether standalone schemes or multi-employer master trust arrangements (where the only benefit provided is a lump sum death benefit). This would be separate and additional to any income tax risks on the amount of the lump sum, as above.

The Government may not have intended these risks to apply to registered life assurance schemes – which are not pension arrangements whereby members build up accrued benefits. It seems a stretch to bring the life assurance trust within the target for this new IHT tax charge by the Government. The whole purpose of the life assurance scheme is to facilitate a quick payment through the discretionary trust mechanism to chosen relatives and beneficiaries in need at the point of the member’s death – the member does not have control of the payments and that is a trustee decision. Nevertheless, this area remains a risk until the position is clarified by the Government.

Reviewing the arrangements

In the light of these risks, employers may want to review their life assurance arrangements and consider use of non-registered policies, whether individual relevant life plans or excepted policies (for the use of two or more employees). These policies fall outside of the tax restrictions mentioned above which apply in respect of registered pension schemes (which catches registered life assurance policies as well). This would safeguard any IHT risks associated with registered life assurance policies, in relation to deaths in service after 6 April 2027.

Excepted policies come with a few potential tax implications themselves, which are often overlooked. There are potential lifetime IHT risks for trustees which can be triggered in certain circumstances (like serious ill health of a member and the 10-year anniversary of the policy). There is no mechanism to account for tax for these schemes, and risks would fall on the trustees as part of their trustee duties. In addition, these policies should not be established with a purpose of tax avoidance – although in practice their sole aim is to provide death benefits for employees, being a legitimate tax planning purpose. There are some special rules, like all members of the policy must have the same benefits and unlike registered policies which can insure annuity benefits, only lump sum benefits can be provided. Also benefits under the policy cannot be paid to another member by the sole reason of any group membership right (unlike business cover type insurance policies which are popular with partnerships and companies).

Taking control

Some employers prefer master trust arrangements to standalone policies. Perhaps because they do not understand the function of trustee for these schemes or do not want to act as a trustee. For that reason, the master trust route can be seen at first blush as an attractive option, particularly if employers are worried about actual or potential tax issues associated with the provision of life assurance benefits.

However, master trust arrangements will be administered by separate trustees, often professional trustees – who will be tasked with making decisions on the payment of benefits. The employer will have paid all the premiums over the years and will have no input into the decision making or control over timescales. This can be a frustration in practice for paternalistic employers wanting to do right by their staff, and ensure the right beneficiary receives the payment. Also, the master trust may cause restrictions on the choice of the underlying insurance policy. Many employers prefer the standalone life scheme route.

It is worthwhile taking advice on the roles and duties of a trustee in relation to these life assurance arrangements and setting up a good transparent trustee decision making process on any claims – a proper understanding of these matters will minimise any complaints brought by disgruntled beneficiaries, whether before the Courts or before the Pensions’ Ombudsman. In this way employers who pay all the premium costs for the policies which provide these death benefits can understand and control the risks associated with the administration of the benefit, so as to see the real value of the benefit for the member’s relatives and other beneficiaries.