Pension scheme members with group life cover may face unexpected tax charges as many employers do not consider the effect the product has on pension tax, according to Aon.
Research from the retirement consultancy, published last week, showed that out of the 1,150 employers surveyed, 67 per cent had not considered the tax implications of lump sum death-in-service benefits on the lifetime allowance.
The lifetime allowance, introduced in 2006, limits the total amount individuals can build up in pension benefits over their lifetime while still enjoying the full tax benefits.
If an individual exceeds the lifetime allowance, which is currently £1.05m, they may face a tax charge on the excess.
The research also showed that only a third of employers have acted to address this issue by using excepted death-in-service cover.
Excepted group life insurance provides tax-free benefits and is sometimes used for high earners. It allows for lump sum benefits to be paid outside of the lifetime allowance, meaning that pension scheme members can avoid a 55 per cent tax charge above the allowance.
This compares to registered group life insurance which provides a tax-free lump sum up to the lifetime allowance.
This is because excepted group life policy is subject to life insurance legislation not pensions legislation and so these life insurance benefits are not tested against the lifetime allowance.
Many people believe that the lifetime allowance only affects high earners, but this is no longer true as growing defined contribution pension values, higher levels of lump sum life cover and the current level of the lifetime allowance mean that mid-earners are also being hit by lifetime allowance tax issues, according to Aon.
Aon stated: "With the generally unknown or at least underestimated impact that lump sum death in service benefits have on an individual’s available lifetime allowance on death, this should be a key topic on the agenda for all employers."
Aon’s research considered whether all lump sum death benefits could be covered by excepted insurance, which would mean that all life assurance cover would be "taken out of the lifetime allowance equation altogether".
The research found that the ‘100 per cent excepted’ eligibility approach increased in popularity among smaller companies.
Aon stated this could be because the approach was "easy to communicate and manage in a smaller organisation, resulting in a greater appetite".
The lower percentage of large employers adopting this approach indicates a continued caution, Aon stated.
However, Ricky Chan, director of IFS Wealth & Pensions, believes it is understandable that most employers have not considered the tax implications of registered group life schemes as their priority is in their business and they may not be experts in tax or employee benefits.
He said: "Employers may think that they’re already doing enough to provide for their employees’ families, but do not realise that the registered group life schemes are subject to the pensions legislation.
"This means that especially for senior executives, the amount of life insurance paid out, is tested against the lifetime allowance along with their other pension benefits, and any excess is taxed up to 55 per cent. So this could leave dependants with less money than initially planned, and the effects are more prominent on young families with children.
"The excepted group life schemes can mitigate the issue as it’s subject to life insurance legislation so is not tested against the lifetime allowance. Hence it’s worth employers speaking with professional advisers to review their existing group scheme benefits especially if they wish to keep their senior staff happy."
Tim Morris, independent financial adviser at Russell & Co believes that the issue with the lifetime allowance is something employers and trustees have a duty of care to highlight.
Mr Morris said: "I'm surprised by the number of companies that haven't taken action, yet having previously worked for a large financial services corporation for many years I've seen many examples of inaction.
"They tend to stay at arms length and recommend their employees take 'independent financial advice', yet don't signpost them to any financial advisers."
amy.austin@ft.com
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