Aviva clarifies excepted group life tax charge scenarios

Steve Bridger, Aviva
Steve Bridger, Aviva

A tax charge of £10,500 could arise from an excepted group life policy payout of £500,000, but creating a new trust and policy prior to the 10-year anniversary of the policy could mitigate the risk of this becoming payable says Aviva.

Issuing a statement to reassure employers and trustees over concerns that tax charges can be levied on excepted group life schemes, Aviva says the small number of scenarios where a charge may arise can be addressed by setting up a new trust and policy before the 10-year anniversary.

Aviva’s statement says no charge is likely to arise where a member is terminally ill at the commencement of a policy.

Periodic charges could be levied, however. A periodic charge is an inheritance tax charge where there is ‘relevant property’ held in a discretionary trust when the trust reaches the 10-year anniversary of when it was set up. An exit charge is also an inheritance tax charge which applies when ‘relevant property’ is subsequently transferred out of the trust.

IHTM17092, HMRC’s inheritance tax manual, states that as an excepted group life policy (EGLP) has little value at its start date, any subsequent distributions as a result of a member’s death within the first 10 years are likely to be taxed at 0 per cent. Experts argue that the only potential value to the policy at its outset is if any of the members were terminally ill at the time. HMRC says any value would be calculated by its board actuary in the event that terminal illness were a factor. Aviva says therefore from an actuarial perspective, the only policy value that could exist for a terminally ill member at the policy outset would be the open market value, since that is the only value allowed by the Inheritance Tax Act. The provider argues that this will be the premium calculated for that individual member, which will be a relatively small amount and will fall below the IHT nil rate band, meaning exit charges are unlikely to apply.

Aviva says periodic charges can arise in two situations – on the death of a member resulting in a claim payment that has yet to be paid out to the beneficiary at the time of the 10th anniversary of the trust, and where a member is terminally ill at the 10th anniversary.

In this latter scenario, where the policy has run the full 10 years, the member may now be uninsurable, which was not the case at the outset of the policy. Aviva says the value could potentially be the total of the sum insured of the member. Aviva adds that this would be the worst-case scenario, as they may be insurable so the market value may just be the premium calculated for them.

If a periodic charge is applicable at the 10-year anniversary an exit charge be due within the following 10 years, says Aviva. The exit charge is based on the period of time between the money being held in trust at the 10th anniversary and subsequently paid out from the trust.
This is measured per quarter over a ten-year period,
with a quarter being three months. If the money held in trust at the 10th anniversary is paid out in the first three months thereafter, then no exit charge would be payable.

Aviva managing director, group protection Steve Bridger says: “We recognise that the issue of periodic and exit charges is causing some confusion in the market. We have worked with our internal tax experts to develop what we believe are the two scenarios when they would potentially apply. I hope that this work we have done provides some clarity and reassurance to employers and advisers who use excepted group life policies.”

How a periodic charge would be calculated

This example calculation is based on the scenario of a member who has died before the 10-year anniversary date but the benefit has yet to be paid to the beneficiary by the anniversary date (no other benefits from any potentially related trusts will be included in this calculation):

Amount of death benefit payable: £500,000 Amount of nil-rate band: £325,000

Total amount above nil rate band = (£500,000 – £325,000) £175,000

Amount above nil rate band multiplied by the Lifetime rate = (£175,000 x 20%) £35,000

After the Lifetime Rate is applied, this figure is multiplied by 3/10ths = (£35,000 x 3/10ths) £10,500

£10,500 is the amount of the Periodic Charge

How an exit charge would be calculated

Using the same scenario used to calculate the Periodic Charge (no previous lifetime transfers or capital withdrawals), the anniversary rate can be shown as;

Amount of periodic charge £10,500/amount of death benefit £500,000 = 2.1%

2.1% is the anniversary rate

£500,000 held in trust at the 10th anniversary paid out 9 months later. Three complete quarters have elapsed.

3/40 x 2.1% x 500,000 = £787.50.

£787.50 is the amount of the exit charge