Tax on Defined Contribution pension pots – is the traditional registered life assurance scheme dead and buried?

Many life assurance policies for employers are held under discretionary trusts and the schemes are technically classed as registered pension schemes under the Finance Act 2004 and regulations. The purpose of these trusts is to allow payment of insured lump sum death benefits (usually multiples of salary at death) by the employer (acting as trustee of the policies) straight to the dependants of the deceased member. This ensures speed of payment and allows flexibility with choice of payment.

It is usually an option of last resort to pay the lump sum direct to the member’s estate, as in that case there would be no control over whom the beneficiary of the lump sum monies would be. This option can be seen as a derogation of the fundamental trustee duty to consider the issue of distribution of funds in a trustee like manner, which unless particular circumstances apply, could be a breach of trust.

Potential issues

The potential question now arises whether the lump sums payable under registered life assurance arrangements will be grouped with the unused DC pots after a member’s death, and whether IHT would be payable as a result on lump sum death benefits. This would seem to run a coach and horses through the basic requirement that all UK registered life policies must be held under discretionary trusts, where the feature of such trusts is to avoid payment to the estate and as a consequence avoid IHT (which only applies to assets of the estate).

We are waiting clarification of whether this will be an issue when the tax changes take place in April 2027. Many employers run parallel excepted life assurance schemes (often applicable for high earners who have historically either taken out tax protections relating to levels of tax relievable pension saving or may be impacted by tax limits due to levels of earnings). In theory these arrangements could be used in place of registered life assurance policies, as excepted schemes and the lump sum benefits provided under them, operate outside the registered tax regime applicable to pensions in the UK. Excepted arrangements have some unusual tax considerations of their own and this may not be such an attractive option for UK employers in terms of overall tax risks.

What should employers do?

This whole issue does seem a potential unintended consequence of the Chancellor’s tax announcement and will hopefully be cleared up by future Government clarification. It will not impact on death claims before 6 April 2027 and so employers should maintain the status quo in relation to their life assurance arrangements but perhaps watch this space with help from their financial advisers, so changes can be contemplated to death in service arrangements should they be required from April 2027. Depending on what the Government says there may be life in the old scheme yet!

Contact our Pensions team if you need advice on your life assurance trust arrangements or other pensions law issues.