A-day 2006 will break the four-times-salary cap on death-in-service benefits, so employers will have a range of insurance options, says Debbie Lovewell
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“In this world, nothing can be said to be certain except death and taxes,”as US founding father Benjamin Franklin was quoted in a letter regarding their newly-signed constitution in 1789.
Neither is typically the most joyful of topics, so positive stories about such issues can be hard to come by, but when it comes to death-in-service benefits, the tax status works in employees’ favour. Historically, should an insured employee pass away while working for an organisation, their dependants or next of kin would receive a tax-free cash lump sum. And while no amount of money can make up for losing a close family member, in some cases, it can make life just that little bit easier for their relatives while they come to terms with the situation.
But for all their uses, group life benefits have never been the most exciting of perks. The limited options available to employers wishing to offer such a scheme means that there is very little scope for creativity, so most employers’ schemes will inevitably look very much alike. Often the only differential is the multiple of salary that firms base the cash payment on, which can range from one-times an employee’s salary up to the current Inland Revenue limit of four-times salary.
But all this is set to change. Incoming changes under the Finance Act 2004 are set to offer employers the chance to shake up their group life offering. Dave Kay, group products marketing manager at UnumProvident, explains: “In many cases, that’s the first time in many years that [employers] can do anything from a death-in-service point of view.”
As he indicates, the changes will mainly affect death-in-service benefits and any related dependants’ pensions. Put simply, from A-Day (6 April 2006), the restriction of death-in-service lump sum benefits to four-times salary will be removed. Instead, the lifetime allowance limit of £1.5 million, which will apply to employees’ pension pots, will also apply. “It’s suddenly brought a more interesting dimension to death-in-service benefits. The link with salary is broken so that’s quite a big change,” adds Kay.
Theoretically, this provides employers with much greater flexibility as to how they structure group life schemes. So those that wish to add a little variety to their offering have a number of options available to them. “Going forward, because there’s a much greater scope to provide a greater lump sum, there is more flexibility to trade in dependants’ pensions,” explains Kay.
One alternative to offering a dependants’ pension along with a lump sum payment is to simply increase the amount payable as a lump sum benefit. Another variation along these lines is for employers to remove any link between death-in-service benefits and salary, instead structuring the scheme around graded sums based on an employee’s position in the organisation. Similarly, employers could choose to offer varying levels of payouts based on factors such as employees’ length of service.
When doing so, however, employers will need to take care that payments do not push staff over the £1.5m limit. While this is only likely to affect high earners, staff that have accrued significant funds in a defined contribution (DC) pension scheme, which is then paid out to dependants, could potentially also be affected. In these cases, the value of the pension at the time of an employees death would be added to the lump sum death-in-service benefit. Jim Aitken, marketing director at Chase de Vere Employee Benefits, explains: “It might seem unlikely that anyone will exceed it, but if they have built up a considerable pension under a defined contribution arrangement, [they could go over the limit].”
Sue Sneddon, employee benefits technical manager at Scottish Equitable and member of industry body Grid, adds that this is something that employers cannot lose sight of. “The death benefits are the last thing that is likely to be paid out.” To avoid high tax charges of 55% on any amount over the limit for which recipients of the cash will be liable, therefore, organisations should bear in mind what other benefits have been previously paid out that will also count towards the lifetime allowance limit.
Unlike schemes permitted under the Inland Revenue’s existing arrangements, such options would enable organisations to utilise group life schemes more effectively to help them recruit and retain staff. And simply providing death-in-service lump sum benefits under a group life scheme may also have other advantages for employers. “It might be simpler to operate and also cheaper. It depends how the dependants’ pension is [currently] paid,” explains Aitken.
He adds that structuring a scheme in this way also enables organisations to fix their potential liability. “If [an employee] died quite young, they would potentially be paying a dependants’ pension for quite some time.”
But in some cases, this may not be the most appropriate solution for staff. Bob Cheesewright, group risk marketing manager at Friends Provident and member of industry body Grid, believes employers should consider whether they have a duty of care to employees’ dependants. “If you are a paternalistic employer, you may say ‘do you want dependants burdened with a huge sum of money at a time of huge emotional stress’?”
Retaining a dependants’ pension alongside lump sum death-in-service benefits, therefore, can help to cultivate a caring image for an organisation.
One option is to tie a review of group life benefits into a wider restructure of an organisation’s benefits package. Placing death-in-service benefits into a flexible benefits scheme, for example, enables employers to contain costs by providing a basic level of cover for staff and allowing them to pay for increased protection depending on their needs and family circumstances.
Whether or not many employers will choose to alter their existing group life arrangements, however, is currently a matter of debate. Sneddon believes that employers will adopt an all-or-nothing approach and either radically change their existing package or alter nothing at all. “It’s effectively an opportunity waiting to be developed. Will organisations totally change what the benefits package is or will they take a step back and think [about what they want]?”
Firms that have little to do in order for their pensions arrangements to comply with the incoming legislation, for example, may not be inclined to significantly alter their group life arrangements. Aitken, however, warns that some organisations simply may not be aware that they have the capacity to make such changes. “Employers may not be aware that pensions simplification also impacts on group risk benefits. Now is the time to carry out a major review as this is a fundamental [change] to pensions and group risk benefits.”
And these benefits are not the only options that the Finance Act is anticipated to impact on. Income protection schemes, which are often included in an organisation’s group risk benefits, could also potentially be affected, albeit indirectly. “One of the benefits that is covered under income protection is pension contribution cover, which if someone is on long-term sick maintains pension contributions. That tends to be cut off at the earnings cap at the moment, but we may not need to use that earnings cap anymore and the contributions could be based on total salary, which is a slight indirect impact,” explains Sneddon.
Overall, the real test for employers will be whether they successfully use the new regulations to design a scheme that best meets the needs of their workforce. As former US president Franklin D Roosevelt commented: “The test of our progress is not whether we add more to the abundance of those who have much, it is whether we provide enough for those that have little.”
From A-Day on 6 April 2006, the restriction of death-in-service lump sum benefits to four-times salary will be removed. Instead, the lifetime allowance limit of £1.5m, which will apply to employees’ pension pots, will also apply to death-in-service lump sum benefits. So this is a good time for employers to review their offering:
Look at the reasons why you introduced death-in-service benefits.
Assess whether the level of benefits meets corporate objectives, for example, does it match those of the company’s pension scheme.
Consult advisers, lawyers and actuaries before making changes to the scheme – employers will have to formally re-register schemes after 6 April 2006.
Look at the tax-efficiencies for employees.