Discover which Life Insurance could mean £1000s more in cash for your loved ones

Life insurance policies and their tax treatment

Life insurance policies with death in service benefits typically fall into three types:

1. A registered group life policy
2. A relevant life policy
3. An excepted group life policy

A Registered Group Life Policy

The most common type of life insurance offering death in service benefits. This type of policy, which must be registered as a scheme with HMRC, covers lump sum benefits payable on the death of an employee. The benefits are not subject to income tax or inheritance tax if distributed outright under a discretionary trust. 

The problem with this type of life insurance is that on the death of a member (and under the age of 75), if the lump sum benefit paid to a beneficiary takes the member’s benefit from all registered pension schemes above the pension lifetime allowance (20/21 it is £1,073,100), then there is a tax charge of 55% on the excess amount.

Example:

• Mr Bloggs current salary is £150,000 p.a.
• Death in Service Benefit is 4x basic salary. This equates to a £600,000 pay-out should Mr Bloggs die whilst in employment.
• Mr Bloggs has accumulated a pension pot worth £750,000.
• Under the rules, the lump sum pay-out of £600,000 is added to the deceased’s accumulated pensions of £750,000 giving a total of £1,350,000.
• The PROBLEM – £1,350,000 exceeds the lifetime allowance of £1,073,100 by £276,900.
• The beneficiaries would pay a tax charge of 55% on the excess amount which in this example, equates to £152,295.
• A large tax bill at the time of bereavement is NOT welcome and can be easily avoided.

A Relevant Life Policy

In contrast, a Relevant Life Policy provides a lump sum benefit on the death of an employee. It is an alternative for employers to a registered group life scheme or it can sit alongside an existing scheme if the employer is willing to fund it or allow the employee to fund it using salary sacrifice. They are taken out and paid for by the employer subject to a Relevant Life Policy Trust. If the employee leaves, they can take the Relevant Life Policy with them to another employer or take over the payment of premiums themselves.

Legislation – Relevant Life Policies were created under the 2006 pension tax simplification legislation that came into force on the 6th of April 2006 (A-day). They are covered by the same legislation that deals with group pension schemes. However, unlike the schemes provided by most big employers, they are ‘non-registered’ so do not fall under pensions legislation.

The BENEFIT – returning to the above example of Mr Bloggs, if Mr Bloggs has a Relevant Life Policy instead of death in service benefit, then the £600,000 pay-out upon his death would not be added to his accumulated pensions. As a result, the pension Lifetime Allowance would not be breached and therefore no tax would need to be paid by their beneficiaries. In this example, the tax saving would be £152,295.

Summary of Benefits with Relevant Life Policy

• Greater tax efficiency than ordinary life policies funded by employers
• The premiums for relevant life cover are tax deductible for employers
• Not classed as a P11D benefit-in-kind by HMRC for employees
• Employees insured by relevant life cover will not pay income tax on the premiums.
• Both the employee and employer also avoid having to pay National Insurance Contributions on the premiums
• Multiples of salary offered in a Relevant Life Plan can be as high as 25x earnings depending on age. An employers group scheme usually offers 4x salary
• Relevant life does not count towards the pensions allowance. Group life schemes do count towards the annual pension lifetime allowance
• Premiums paid also do not form part of (and so do not reduce) the employee’s annual allowance (i.e., the amount that can be contributed by or on behalf of an individual to any registered pension scheme with the benefit of tax relief)

How a Relevant Life Policy can cut company costs

The example below assumes that the Company adds £1,000 to the individual’s salary so they can pay for life cover through their net pay. The actual net cost of this is £1,589. In the Relevant Life column, we see the effect of the employer paying for the premiums, a difference of £779.27.

Source: Legal & General

Assumptions:

• Corporation tax relief is 19% and is granted under the ‘wholly & exclusively’ rules
• Employer will pay National Insurance at the rate of 13.8%
• In both cases, a payment of £1,000 each year is paid for the life cover on an employee who is paying income tax at 40% & employees NICs at 2% on top end income

An Excepted Group Life Policy

An Excepted Group Life Policy is in all material respects, identical in character to the Relevant Life Policy, except that it is designed for a group of employees as opposed to a single employee. The principal distinguishing feature between it and a Registered Group Life Policy is that a lump sum benefit provided by an Excepted Group Life Policy does not count towards a member’s lifetime allowance. Otherwise, it shares the same characteristics as a Registered Group Life Policy.

Who are Relevant Life Plans ideal for?

• People with high earnings and big pension funds who don’t want their death in service benefits to form part of their lifetime allowance.
• Small businesses that do not have enough eligible employees for a group life scheme.
• People who are currently in a group death in service scheme that does not allow voluntary increases or has restrictive definitions of remuneration.
• People in a group death in service scheme who do not want their cover linked to salary at death but need a fixed sum.

Our Conclusion

Having the right life insurance death benefits in place could save pension beneficiaries thousands of pounds in tax. Employers should investigate switching life insurance death in service policies for relevant life policies or operate a traditional death in service benefit alongside Relevant Life or Excepted Group Life Policy. If you have any question or would like to know more, please get in touch.

Notes:

• The Financial Conduct Authority does not regulate Tax Planning
• Tax Treatment varies according to individual circumstances, and is subject to change.