Excepted group life policies (EGLPs) are life assurance policies taken out by employers to provide lump sum death-in-service payments to dependants of policy members.
The roots of EGLPs go back to 1989 when the government introduced an upper limit (earnings cap), set at £60,000, on remuneration on which pension benefits and contributions could be based. In those pre-simplification days, occupational lump sum death-in-service benefits were limited to a multiple of four times earnings.
Unapproved group life policies were used from 1989 to top up group life cover when the cap was introduced but, in practice, were not an effective solution. If there was more than one death claim under a single policy, the second and subsequent claims triggered a tax charge under the life assurance policy qualifying rules (Income and Corporation Taxes Act 1988). The 2003 Budget introduced EGLPs, intended to address the unintended tax consequences and to provide a sound base for death benefits written outside pension arrangements.
The tax rules setting out the restrictions applying to EGLPs are set out in s480 of the Income Tax (Trading and Other Income) Act 2005. An EGLP must satisfy seven conditions set out in s481 and s482. In summary, these conditions are:
1. A capital sum only must be payable on the death of each life assured before a specified age not greater than 75.
2. The benefit payable on each death must be calculated on the same basis and any limitations applied uniformly.
3. Any surrender value under a policy cannot exceed the premium referable to the unexpired risk under the policy. This rule enables a refund of premium to be made on cancellation.
4. Only the sums and benefits under conditions 1 and 3 can be paid or conferred under the policy.
5. Any benefits may only be paid to, or applied on behalf of, an individual or charity beneficially entitled to them.
6. No benefit can be paid, directly or indirectly, to a life assured, or a person connected to a life assured, on the death of another life assured.
7. Tax avoidance must not be the main purpose or one of the main purposes of the insurance.
The number of in-force EGLPs and insured members has grown rapidly, especially over the past three years. Since Swiss Re began collecting data, the number of policies has increased more than threefold and the number of policy members more than doubled. In 2015 and 2016, the number of policy members increased by more than 25 per cent and 31 per cent respectively.
Year EGLPs Policy members
2010 2,053 312,222
2011 1,974 311,379
2012 2,307 344,889
2013 2,877 334,742
2014 3,951 391,438
2015 5,187 490,911
2016 6,239 644,492
On the face of it, EGLPs have been a great success with factors driving the increase in their use including the pensions savings lifetime allowance reduction to £1m as lump sum death benefit payments from registered pension arrangements count towards the lifetime allowance, while EGLPs do not.
An EGLP can provide a simple life assurance policy to cover all members of a workforce as well as being a helpful way to provide lump sum benefits free of any lifetime allowance issues. Nonetheless, advice needs to be taken since the tax consequences of doing so can be uncertain. Despite the impressive growth, EGLP policy members still account for just over 7 per cent of all people with insured group life cover.
Discretion needed
Death in service benefit payments paid from registered pension schemes are free of tax. This speeds up payment to chosen beneficiaries outside the estate of the deceased. It also gives discretion where nominations may not have been kept up to date and can be very helpful as people live increasingly complex lives. It is useful for those dying without issue.
To achieve the same aim, EGLPs are written subject to a non-pension discretionary trust and this is where care is needed.
Potential tax charges
The trusts governing non-pension schemes can incur entry, exit and periodic (10-year) charges introduced to curtail inappropriate use of trusts as vehicle for investments (s64 and s66, IHTA 1984).
Trusts set up to distribute the proceeds of EGLPs were not the intended target of this legislation, but are currently subject to it. Trustees have to make returns of IHT charges on capital paid out of the trusts and at 10-yearly anniversaries. If information comes to light that means an IHT return should have been made, or that a return was made, but is not correct, then trustees should make a return, or an amended return, as soon as possible.
Given that benefits provided can only be on death, it might be questioned why tax charges could ever apply since there is no investment gain. There are several instances where this can happen.
One example is where an insurer had settled a death claim from the trustees when the trust passed a 10-year anniversary, but the trustees had not distributed the benefit to dependants. A further example might be where a death had occurred during the 10-year period, but no claim had been submitted.
A terminal problem
HMRC has indicated that there is also value in the trust if a member is terminally ill at the 10-year point, based on a definition of "fewer than 12 months to live". It has also indicated that, for deaths occurring between years 10 and 11, trustees should check whether the deceased was terminally ill at the 10-year point and, if so, make a further return.
This highlights the arbitrary nature of the charge. The potential liability only arises in connection with a terminally-ill policy member. It does not apply otherwise, such as where a policy member dies in an accident.
If two policy members were to die on the same day, one in an accident and another from cancer, and the deaths occurred 10 years and one day after the trust was set up, there would be no tax liability in the first instance. The second would trigger a possible tax liability if there was clear evidence that the policy member had been terminally ill on the previous day.
The fact that a policy member is terminally ill can trigger a tax charge under the trust despite an EGLP only being able to pay the policy proceeds on death (condition 1 above) and not when the member is diagnosed as being terminally ill. There are also practical issues: trustees might be unaware that a policy member had been terminally ill. It is doubtful whether the deceased's GP would be prepared to confirm that to the trustees after death.
Any tax liability falls on the trustees. Although the trust deeds might limit liability, nonetheless a payment will need to be made by somebody. This could be the sponsoring employer.
If it was possible to reclaim the tax from the policy proceeds, this would present a reputational issue for the employer, trustees and insurer. It could even be seen as discriminatory against the successors of the deceased who might have been through the trauma of nursing them during a terminal illness.
Key points
- Unapproved group life policies were used from 1989 to top up group life cover.
- Life assurance cover is the simplest of long-term products.
- The tax regime currently adds complexity to setting up EGLPs.
The future
Employer-sponsored life cover, whether through a registered pension scheme or an EGLP, is the only life cover many low to medium-earners hold and provides about 40 per cent of all insured life cover in the UK.
Life assurance cover is the simplest of long-term products, paying a sum quickly to dependants when death occurs. The average insured benefit per member is just over £200,000, so it is not just very high earners who benefit from membership of EGLPs. Consequently, it should be in the government's interests to encourage provision if society is to become more resilient to the financial consequences of life's shocks.
As retirement ages increase due to the rising state pension age, EGLPs could become more attractive as the risk of dying while still employed increases.
The tax regime currently adds complexity and uncertainty to setting up EGLPs with appropriate trust documentation. The administration can be costly for employers and can deter them from acting to provide cover. To remove this, trusts holding EGLPs as a sole asset could be exempted from the discretionary trust tax regime for which they were surely not intended so that potential payments are ignored. Based on government statistics, Swiss Re has estimated that the tax, which would be foregone if an exemption was granted, is no more than about £1m.
The requirement for a common benefit formula across all policy members (condition 2 above) adds some complexity to setting up EGLPs and is not ideal. Where cover for groups of employees is based on different benefit calculations, a separate policy is required for each group.
This is administratively complex and it is not clear what potential tax leakage, if any, it is intended to address. Removing this would allow member coverage to be on a consistent basis with registered group life cover. For underwriting and risk management purposes, insurers pool these policies. Within the registered scheme environment, the same effect is achieved by allowing different categories within the same policy, simplifying the accounting and other administration.
With 93 per cent of all insured lump sum death policy members still in registered pension arrangements, any reforms to the rate of pension tax relief on contributions could impact the group life market negatively.
Over time, we are seeing a gradual separation of death benefits from pensions as the number of EGLPs increases. Sensible reforms to the EGLP restrictions and to the taxation of trusts holding such policies would enable the market to continue to grow with confidence.
Ron Wheatcroft is technical manager of Swiss Re Europe
