Terminal illness tax lottery fails to deter excepted group life boom

Increasing numbers of employers face a terminal illness tax lottery because of HMRC rules that levy tax on life cover where employees are struck by conditions that give them 12 months to live but do not tax those who die suddenly.

The problem is faced by employers offering excepted group life policies (EGLPs), which are used to offer non-taxable death in service benefits to employees outside a registered pension arrangement because those individuals have pension savings at or near the pension lifetime allowance (LTA).

EGPLs are impacted by legislation intended to restrict misuse of discretionary trusts for investments. These rules say that there is deemed to be value in the trust if a member is terminally ill – with “fewer than 12 months to live” – at the trust’s 10-year point. This means the trust could be liable to a 6 per cent tax charge on the value of the payout if an employee contracts a terminal illness before the 10th anniversary of the trust being set up and dies within 12 months, but would not be taxed if the individual died on the same date but through a sudden death such as through a fatal heart attack. A tax charge can also be levied if there is a member with 12 months to live at the time of the establishment or termination of the trust.

The number of EGLPs in place has more than doubled in the last five years, as employers adapt to drastic cuts to the LTA.

In 2016, when the LTA stood at £1m there were more than 640,000 people covered in 6,239 EGLP schemes, compared to just 2,307 schemes in 2012, when the LTA stood at £1.8m, figures from Swiss Re show.

The issue is only beginning to emerge now because EGLP schemes started to become mainstream as a result of the 2006 pension simplification rules that introduced the LTA – then £1.5m. While only a trickle of schemes will have reached their 10-year anniversary to date, this number is set to increase considerably over the coming years. Experts report that some intermediaries are refusing to advise on the problem, instead referring employers to lawyers.

Swiss Re, which has been pushing the Government for an exception for EGLPs calculates the cost to employers of administering measures to avoid the tax charge stands at around £1.7m, while revenue received by HMRC stands at around £1m. However, with a potential rule change requiring primary legislation, it is unclear whether the Government will be interested in changing the rules.

In-force EGLP sums assured at the end of 2016 were £129bn, an increase of 145 per cent on their 2012 level, while registered pension lump sum death benefits have grown by 21 per cent over the same period. Over the same period, in-force EGLP premiums increased by 132 per cent while registered pension lump sum death benefit premiums have grown by 24 per cent.

The average in-force EGLP member sum assured is £200,932, compared with £110,706 for lives covered under registered arrangements.

Relevant life policies, sales of which have also surged in recent years, are also affected by the same terminal illness tax lottery.

The number of new sales of Relevant Life Policies (RLPs), individual policies paid for by employers, has grown from 14,515 in 2013, to 27,746 in 2016 when the average sum assured was £424,774 and total new premiums stood at £26.6bn. In-force total premiums now stand at £49.4m, covering over 52,000 people.

Swiss Re technical director Ron Wheatcroft says: “On the face of it, EGLPs have been a great success. Despite the impressive growth, however, EGLP policy members still only account for just over 7 per cent of all people with insured group life cover.

“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 or for those dying without issue.

“Despite the growth in non-registered death-in services benefits, 85.9 per cent of all employer-paid lump sum life cover is still in registered pension arrangements rather than in an EGLP or RLP.

“Any reforms to the rate of pension tax relief on contributions, such as limiting relief to a flat 30 per cent, could impact the registered group life market negatively and reforms to the EGLP restrictions and to the taxation of trusts holding such policies would enable the market to continue to grow with confidence.

“Employer-sponsored life cover, whether through a registered pension scheme or an EGLP can be the only life cover many low- to medium-earners hold with RLPs providing similar access to employer arrangements for smaller firms. With such arrangements providing around 40 per cent of all insured life cover in the UK, Government should ensure that provision is simple, in the interests of greater financial resilience.”

Ellipse chief marketing officer Chris Morgan says: “This quirk, that impacts schemes where a member contracts a terminal illness, is a definite concern for employers. It is not the fault of the employer if one of their employees contracts a terminal illness, but one of the downsides of EGLPs is this problem around what happens at the 10th anniversary. We offer a professionally administered excepted life trust that takes the burden of winding up the trust away from the employer.

“In short, this is absolutely an issue that advisers and employers should take into consideration when establishing an excepted policy, and again when approaching the 10 year anniversary.”