Article in full
Employers go into 2006 facing two more discrimination ‘must-avoids’. Any employee benefits promised for spouses only will need to be revisited as a result of the Civil Partnership Act. And on the disability discrimination front, the change to the definition of ‘disability’ will bring employees with progressive conditions under the protection of the legislation on diagnosis of their condition rather than when the condition causes significant adverse effects. Employers will need to be on their toes.
But it doesn’t stop there. The tax simplification changes, well recognised as impacting on pension schemes, will also impact on any group life cover they provide for their workforce. Making the wrong decisions about the life cover they provide could bring tax consequences for the individuals and/or their dependants because of the way the new tax rules are designed to work.
Today things are very clear cut – we have a four times salary limit on lump sums, the earnings cap, and a four-ninths maximum dependant’s pension. Their combined effect has resulted in employers running with two types of group life scheme – approved (covering benefits up to HM Revenue & Customs limits) and unapproved top-ups to cater for the rest.
>From April, however, new tax controls will come into play. Allowances will be used to control tax advantages on monies in and out of approved (soon to be called ‘registered’) schemes. The new lifetime allowance (starting at £1.5 million) will be used to control the tax privileges on all benefits paid out for an individual across all registered schemes throughout his or her working lifetime. There are eight different circumstances in which benefits will need to be checked against this lifetime allowance, and payment of a lump sum benefit on death is one. Dependants’ pensions are ignored for this; they will continue to be taxed as earned income, but with no four-ninths limit.
In theory, most people can have much bigger tax-free lump sums. And there’s an argument that this will be more tax efficient than dependants’ pensions. But this leaves employers with a few questions to consider – do they need to change their benefit structure, do they want to and is there any downside if they do or don’t take action?
What some may not fully appreciate is that the decisions they make here, although beneficial for most employees, could seriously damage the pensions and tax planning for others. The days of looking at group life in isolation are numbered – or should be – if employers want to make sure they don’t leave themselves open to comeback further down the line. The following examples may help explain.
Mr A has worked for ABC Ltd man and boy. With 35 years’ service, a salary of £75,000 and a defined benefit (final salary) pension, he is fairly happy with his lot. In June 2006, he retires early on full pension of £50,000, happy that ABC Ltd is keeping his four times salary life cover going up to his normal retirement age. Sadly, two years later Mr A dies, and the scheme trustees pay out £300,000 to his beneficiaries. Are there any tax consequences? Not this time – his total benefits (with the pension valued at £1m) are within the lifetime allowance.
Then there’s Mrs B, recently headhunted from a competitor at a very senior level. Because her pension savings from previous jobs are already worth £3 million, she’s taken advantage of the Revenue option to ringfence her existing benefits (applying for enhanced protection) to avoid any tax charges. Mrs B doesn’t tell ABC Ltd and it doesn’t ask any questions before putting her in its group life scheme. Oops – it has just unravelled her enhanced protection, leaving her open to a tax charge on £1.5 million of those pension benefits, with her dependants liable for tax on the whole lump sum if she dies.
Once enhanced protection is lost, there’s no way back – and with a 55% tax charge, that’s quite a penalty! Something that could perhaps have been avoided had ABC Ltd clearly communicated its strategy on issues like this – perhaps as early as recruitment stage.
Employers shouldn’t be expected to take sole responsibility for this, but will need help from both risk and pensions advisers to understand the issues. Good advisers should be able to work together to help employers overcome whatever regulatory hurdles the government throws at them.