Trust-based life assurance cover enables employers to provide a tax-free lump sum benefit for an employee's family and dependants should the employee die in service. Following the closure of many final salary pension arrangements, most employers use a separate insured scheme and policy to provide death in service cover to their employees.
We look at the different types of insurance policies available and the trusts used to hold those policies, along with some common problems employers face when providing group life cover.
What types of group life assurance policy are available?
Group life protection broadly falls into three different types of policy:
- Policies held in registered group life schemes - this policy should be held in a trust which will need to be registered with HMRC and, although the only benefits payable will be death in service lump sums, is subject to the same tax treatment as a registered pension scheme.
- An excepted group life policy - this is a policy designed to be held in a discretionary trust which does not require registration with HMRC. The advantage of these policies is that the death benefits are not treated as pensions savings for tax purposes and therefore are outside of the calculation for a member/beneficiary's lifetime allowance. These types of trust are considered further later on in this note.
- A relevant life policy - very similar to an excepted group life policy, these are single-life policies used for named individuals (often senior executives with significant pension savings) and also held within a discretionary trust. Many of the issues associated with their use are covered under the excepted group life policy section (below), but advice should be sought when making use of the policy or setting up the trust.
Why should these policies be held via a discretionary trust?
Discretionary trusts are used in order to separate out the death in service benefits paid by the insurer from the deceased's estate and, under current tax rules, to allow them to be paid "tax-free". By paying benefits from a policy through a discretionary trust, rather than through a direct policy held in the employee's name, the lump sum will not be subject to inheritance tax. There must be a discretion granted to the trustees as to who should receive benefits from the trust, and that decision will need to be made on a case by case basis.
Who should act as trustee?
The vast majority of group life trusts appoint the sponsoring employer as the trustee (as well as fulfilling the role of principal employer). This allows the employer to control both the renewal of the policy (and payment of the premium) as well as exercising discretion to pay out benefits to the relevant beneficiaries (e.g. the deceased member's spouse, relatives or dependants).
The role imposes very few ongoing administrative requirements on the trustee. Indeed, once the trust is established (and registered with HMRC, if required), the only time the trustee needs to take any action is upon the death of a member and payment from the policy into the trust, at which point a decision must be made about which beneficiary(ies) to pay benefits to. In many cases this will be straightforward. In cases of doubt the trustee should seek legal advice before paying benefits. This is important as the trustee needs to ensure it is acting in line with both the rules of the trust and trust law principles, and that it is taking all reasonable steps to avoid future claims from disappointed potential beneficiaries.
What sort of problems arise with registered group life policies/trusts?
Registered policies are the most common form of group life arrangement and require the employer to establish a registered trust in order to pay benefits out free of tax. These trusts are set up in a similar way to an occupational pension scheme, but they do not require the ongoing management and trusteeship burdens associated with a pension scheme. However, the benefits that are payable need to remain within a limit set by HMRC and conform to a range of statutory restrictions.
Most employers will have set up a registered group life trust many years ago and will not regularly update the trust documentation, as the trust will only be used in the event of an employee dying in service. Often trust documents sit on a shelf and only get dusted off when a death occurs - which can lead to the following common problems:
- Missing documentation - where employers established a trust and registered it with HMRC many years ago but have mislaid the governing documents.
- Outdated trust provisions - many trusts were established before the Finance Act 2004 and subsequent tax legislation which made fundamental changes to the regime covering group life trusts. The trust deed therefore will often benefit from being updated with a deed of amendment to bring it into line with legislation and best practice, to ensure that the trustees are acting in accordance with current tax and trust law.
- Overlapping/competing trust documentation - in many cases the employer will have changed insurer over the years, usually to get a lower premium on the life assurance policy. This process sometimes involves signing up to a new trust deed based on that insurer's standard documents, and some employers are left with two (or more) trust documents for the same scheme (or separate from one another) with different rules. This can be problematic both from a tax perspective and in the event of a death in service.
- Conflicting provisions between the trust deed and the policy - it's important that the trust deed and policy are consistent, especially when it comes to the eligibility of employees for cover and the amount payable. If the trust deed confers benefits that are not insured under the policy the employer may be liable to pay these benefits even if the insurer will not.
- Outdated or missing expression of wish forms - when it comes to deciding how to distribute death benefits it is easier for the trustee of the group life trust where the deceased member had made a relatively recent expression of wish form. In practice these forms have often been lost over time, are out of date, or relate to a previous arrangement or trust. Asking members to update these expression of wish forms should be done on a regular basis.
What is an excepted group life policy (EGLP) and what are the advantages to using one?
An EGLP does not sit within current pensions tax legislation and so the lump sum payable from it will not count towards an employee's pensions lifetime allowance (LTA), provided it is paid through a discretionary trust and conforms to certain statutory criteria.
EGLPs have become popular in recent years as the LTA limit has decreased rapidly, with many high earners having applied for protection against the LTA either when it was introduced or when the limit fell in 2012, 2014 and 2016.
The key advantages of using an EGLP are:
- Lump sum death benefits are not included in the calculation of a member's (or beneficiary's) LTA.
- The cost of providing the benefit is normally treated as a business expense and receives the same tax-favoured treatment as a registered group life arrangement.
- Provided the EGLP's range of potential beneficiaries complies with HMRC's rules, premiums paid by the employer should not be treated as a 'benefit in kind' on the employee and are therefore not taxed.
- Employees with tax protection against the LTA can participate in an excepted scheme without the risk of losing their transitional protection.
- As the trustees have discretion over the recipient of any payment of the death benefits, the lump sum should not ordinarily be treated as taxable within the member's estate.
What are the potential problems with using an EGLP?
We recommend that all employers take legal advice when using an EGLP. Some of the key issues to bear in mind are:
- It is important that the policy is not taken out where the main purpose or one of the main purposes is to avoid tax. This is specifically mentioned in the relevant tax legislation, although generally the EGLP can be used where the primary purpose is to provide death in service benefits. Care needs to be taken in deciding which employees will be eligible and what the purpose of the EGLP/trust is;
- There can be potential inheritance tax issues (although payments are not normally part of the member's taxable estate) where an employee has a terminal ill health condition at the outset of the EGLP; and
- The trust is subject to periodic review by HMRC and possible tax charges at each 10 year anniversary on any property held within the EGLP trust at that point (e.g. a benefit that has been paid in to the trust by the insurer but not yet distributed to a member's beneficiaries).
So what should we do?
If you've got an old registered trust deed gathering cobwebs in a filing cupboard, now would be a good time to dust it off, or more importantly, check it's still there! Ask your benefit consultants or broker what your current arrangements are and consider whether an EGLP might work for you. We offer a complimentary review of your current trust documentation to help with that assessment. Do feel free to get in touch with us too.
We have also published a group life trust 'top tips' sheet for employers.