In this issue’s Technical Connection article, John Woolley takes an in-depth look at planning with relevant life policies and EGLPs
Group life assurance used to be a common form of planning for employers that wished to provide life assurance benefits for their employees.
When arranged as part of a registered pension scheme, contributions and benefits will receive beneficial tax treatment. However, restrictions apply as to the amount of benefit that can be paid from a registered pension scheme in the shape of the lifetime allowance (LTA), and lump sum benefits paid in excess of the LTA that applies for a particular employee will be subject to tax at 55%. With the gradual reduction of the LTA until 2016, unless they have elected for protection, more and more people were affected. It now stands at £1.055m for 2019/20, rising by CPI each year.
For this reason, employers may look to provide additional life cover protection via an unapproved group life assurance plan that is not part of a registered pension scheme. Unfortunately, many tax issues lurk here in the shape of possible chargeable event tax problems on benefit payments after the first death and the possible treatment of the plan/scheme as an employer-financed retirement benefits scheme (EFRBS). Such treatment will mean that any benefits paid out of the EFRBS will be taxed on the employee unless contributions to the EFRBS are subject to the disguised remuneration rules.
To be taxed as an EFRBS, a plan must provide “relevant benefits” and this expression includes death benefits. Furthermore, employer payments into most EFRBS are now subject to the disguised remuneration tax rules, which will result in a tax liability on the employee based on the employer contribution.
However, exclusions from the EFRBS tax rules exist for certain policies set up on the life of an employee (relevant life policy or excepted group life policy (EGLP)), that pay benefits on an individual’s death.
The benefits paid under an EGLP and relevant life policy are not treated as relevant benefits (because they are excluded benefits) for these purposes, so such policies are not taxed in the same way as an EFRBS (ITEPA 2003, s. 393B (3)).
Employer contributions to an EGLP and individual relevant life policy are also excluded from taxation on the employee under the disguised remuneration tax rules.
This means that where an employer wishes to provide additional life cover outside of the registered pension scheme, an EGLP or a single-life relevant life policy may well be an attractive proposition.
We now look at these two policies in detail below.
1Excepted group life policy
An EGLP can be used where it is desired to effect a policy on the lives of several people who are linked through work. So, for example, the policy could be on the lives of a number of employees of one employer or on the lives of several partners in a partnership. The policy can only pay death benefits on an individual’s death under age 75. The policy will be subject to a trust so that in the event of the death of a life assured, death benefits can be paid by the trustees to the deceased’s dependants. It is a condition that death benefits must not be paid to the other lives assured (ie employees or partners) unless they benefit as a spouse or dependant of a life assured who has died. Also, the same method for calculation of the capital sum and any limitation, such as a stated fixed benefit or multiple of earnings, must be applied to all members.
As EGLPs are primarily designed to be acceptable employee benefits, they should not be subject to IHT under the relevant property trust regime
1.1 Tax implications of an EGLP
Provided the various conditions set out in ITEPA 2003, s. 393(B) and ITTOIA 2005, s. 480-483 are satisfied, the income tax/corporation tax/inheritance tax (IHT) implications of an EGLP will be as set out below.
These depend on whether the lives assured are employees or partners.
(a) Where the policy is on the lives of employees Income tax/corporation tax
- Premium payments in respect of employees should be deductible for the premium payer for tax purposes.
- There will be no employment income tax on the payment of death benefits.
- Because the policy is an EGLP, it is not subject to the chargeable event legislation and so no chargeable event gain arises when policy proceeds are paid to the trustees. Previous payments made under the policy will be excluded for these purposes (so this addresses the problem that existed under older group life policies).
- It is thought that premium payments will not be assessable on the employees concerned on the basis that, as the policy is subject to a discretionary trust, no benefit arises for the employee (or a member of his family or household) when the premium is paid. In the past, it has been HMRC’s view that in order to avoid a benefit-in-kind charge on an employee in respect of premiums paid by the employer, any benefits must be paid to the employee, the employee’s family or a member of his household (ITEPA 2003 s307). It has been acknowledged that this condition is unduly restrictive, so clause 11 has been included in the Finance (No. 3) Bill 2017-2019, which will mean that from 6 April 2019 the law will be amended so that the class of recipient beneficiary will be extended to any other individual or to a charity.
When premiums are paid to the policy held subject to the trust, there will be no lifetime charge to IHT if the employer is a non-close company, as a corporation cannot make a transfer of value.
Where the employer is a close company, no lifetime charge will arise because the premium (or the appropriate proportion of it) will be treated as part of the employee’s remuneration package and so will be covered by the exemption in IHTA 1984, s. 12 or be covered by the “no intention to confer a gratuitous benefit” exemption in IHTA 1984, s. 10. A close company is one controlled by five or fewer shareholders, or shareholders who are all directors.
As the policy will be subject to a discretionary trust, there could be periodic 10-yearly charges and an exit charge when cash is paid out of the trust to a beneficiary. In this respect, it should be noted that:
- HMRC regards the employer (not the employee) as the settlor of the trust for IHT purposes.
- As the employer is the settlor, there will therefore be no need to determine a seven-year cumulation period (unless the employer is a close company when the creation of the trust could be attributable to the shareholders).
- Given that the policy underlying an EGLP is a temporary assurance with no value, an IHT periodic charge is unlikely. A periodic charge is only capable of applying where:
o Some or all of the cash arising on the payment of death benefits remains in the trust at a 10-year anniversary, or
o A life assured is seriously or terminally ill at a 10-year anniversary so the policy has a market value.
In this respect, the trustees will be entitled to the standard nil rate band at the 10-year anniversary. Payments made out of the trust in the previous 10 years would need to be taken into account as would (in the case of an employer who is a close company) chargeable transfers made by shareholders in the employer company in the seven years before the trust was created.
- For an exit charge to arise, the trust would need to have some value at the last 10-year anniversary (see above). If the exit is in the first 10 years, there would have needed to have been a tax charge when the policy was first placed into trust. Clearly, this is unlikely to be the case.
This is a simplification of the IHT position. As stated, in most cases IHT will not arise but there could be complications where several deaths have occurred so that several payments are made out of the same policy before a 10-year anniversary (see (b) below).
An EGLP can be used where it is desired to effect a policy on the lives of several people who are linked through
(b) Where the policy is on the lives of partners in a partnership
In the case of a policy on the lives of partners, the following is the position:
- Premium payments will normally be paid by the partnership on behalf of the partners and will be debited in the appropriate proportion from each partner’s general account
- Premium payments will not be eligible for income tax relief
- There will be no income tax on the payment of death benefits.
An EGLP taken out by a partnership (ie by the partners or, where a large number of partners is involved, one or two of the senior partners as nominees on behalf of the partners) on the lives of partners (ie themselves) and
held in trust for the benefit of the families of the partners would, it is thought, normally give rise to the following IHT implications:
- Under section 44 of the IHT Act 1984, each of the partners would be regarded as the settlor of their own separate trust comprising of a fractional share of the trust assets (ie the EGLP and any undistributed cash payments) in line with their entitlement to the capital of the partnership.
- The fractional premiums paid by each partner would be a transfer of value for IHT purposes. These would normally fall within the partner’s annual or normal expenditure out of income exemptions. To the extent they exceed these, they should fall within the partner’s nil rate band. No gift with reservation of benefit should apply, provided the partner cannot benefit under the arrangement.
Each of these individual trusts will have its own IHT nil rate band, which may be reduced by any chargeable lifetime transfers made by the partner concerned in the seven years before the trust was established.
Furthermore, as explained above, because a temporary assurance will only have a significant value on the life assured’s death or serious ill health, in general there should not be any significant problems with periodic or exit charges on the trust. However, the position can become considerably more complicated where an EGLP has a large number of lives assured, so regular benefit payments are being made out of this trust. This is because payments out of the trust in the previous 10 years will be taken into account in determining the available nil rate band at a 10-year anniversary.
In the author’s view, as EGLPs are primarily designed to be acceptable employee benefits, they should not be subject to IHT under the relevant property trust regime, and hopefully the Office of Tax Simplification will take this point on board when it reports back to the Treasury with suggested technical reforms as part of its IHT simplification report.
2 Relevant life policy
In what follows, we use the expression “relevant life policy” to refer to a policy effected by an employer on the life of a single employee, which is placed in trust for his or her beneficiaries. Technically, a relevant life policy also includes an EGLP.
2.2 Nature of a relevant life policy
A relevant life policy is a policy effected by an employer on the life of an employee. The policy is effected subject to a discretionary trust for the benefit of the employee’s dependants.
Under ITEPA 2003 and ITTOIA 2005, the conditions that need to be met for a policy to be a relevant life policy and qualify for the various tax concessions are:
- it is a term assurance policy effected by an employer on the life of an employee and funded by the employer;
- a capital sum is payable on the death of a single insured person under the age of 75;
- the policy does not have, and is not capable of acquiring, a surrender value;
- No other sums or other benefits may be paid under the policy. As well as a death benefit, it is possible to provide a benefit on serious ill health/disablement of an employee during service that leads to termination of employment. Therefore, for example, terminal illness benefit could be included as a benefit;
- Any sums payable or other benefits arising under the policy must be paid to or for, or conferred on, or applied at the direction of:
A. An individual or charity beneficially entitled to them, or
B. A trustee who will ensure that the sums or other benefits are paid to or applied in favour of an individual or charity beneficially; and
- Tax avoidance must not be the main purpose, or one of the main purposes, for the policyholder (the employer) or any person beneficially entitled under the policy.
2.3 The tax implications and tax benefits of a relevant life policy
A number of tax and other benefits arise in connection with a relevant life policy. For example:
- The death benefit will not form part of or affect the employee’s lifetime allowance for pension purposes
- Subject to satisfying the “wholly and exclusively” test, premiums paid by the employer can be treated as a business expense for tax purposes
- Premiums paid by the employer are not treated as a benefit in kind or otherwise taxable on the member (life assured) – see 1.1(a) for more commentary on this
- The premiums paid do not count as part of the employee’s annual allowance, ie the amount that can be contributed by or on behalf of an individual to any registered pension scheme with the benefit of tax relief
- Premiums are not subject to employer/employee’s National Insurance contributions
- Any benefit payments are free of income tax
- The death benefit will not form part of the employee’s estate for IHT purposes
- While death benefits will be paid to a discretionary trust so the relevant property regime will theoretically apply, it is most unlikely that 10-year periodic charges or exit charges will apply
- No income tax chargeable event gain will arise, because the policy has no surrender value.
2.4 Other important issues with relevant life policies
(a) The payment of benefits under a relevant life policy on the employee’s death
In general, only death benefits will be provided under a relevant life policy. However, it is understood that serious ill-health/disability benefits leading to termination of employment (including terminal illness benefits) can
There are no other tax implications as long as the employee is alive. Once the death benefit is paid to the trustees, the normal IHT rules, which apply to the taxation of discretionary trusts, will apply as the trustees will hold the death benefit on discretionary trust. This will mean that there could be potential 10-year periodic charges and exit charges.
The benefit will be paid by the insurance company to the trustees of the relevant life policy trust. The trustees will have discretion as to who should receive the death benefit (and/or disability benefits) from the classes of beneficiaries specified in the trust, who would normally include the employee. If a disability benefit becomes payable, it is expected that the trustees will pay it to the employee. Because premiums are only paid by the employer, the gift with reservation of benefit rules will not apply.
On the death of the employee, the policy proceeds will be paid to the trustees. The trustees can irrevocably appoint the benefits of the trust (ie the policy proceeds) to any of the potential beneficiaries under the trust.
Under an irrevocable beneficiary appointment, once an appointment is made it cannot be changed. For this reason, appointments should only be made after careful consideration. Tax advice should therefore be taken before considering any appointment.
The employee can, and should, complete an expression-of-wishes form to indicate to the trustees to whom he would wish them to pay the death benefits. This is a non-binding expression of wishes and is similar to the method of nominating beneficiaries under a registered pension scheme.
(b) The trustees of the relevant life policy trust
The employer would normally be the trustee of the trust of the relevant life policy. The trust deed would usually allow for the appointment of other trustees, which would commonly include an independent person or a member of the employee’s family.
While additional trustees are not strictly necessary, especially where the employer is willing to act as the sole trustee, for practical reasons it may be advisable to appoint additional trustees.
(c) Employee leaving service
The purpose of a relevant life policy is to provide death-in-service benefits for current employees, and policies should be taken out for this reason. If an employee leaves service (other than through death), the policy can only continue being treated as a relevant life policy if it continues to satisfy the appropriate legislation. In effect, this will mean that any new employer could take over premium payments and become the trustee.
If, on the other hand, the employee leaves service and intends to continue the policy himself by making premium payments, care will need to be exercised. In these circumstances, if the employee is a beneficiary under the trust then, in order to avoid the IHT gift with reservation of benefit rules, he should give up his interest as a potential beneficiary under the trust. This can be achieved by using an appropriate disclaimer form or by the trustees exercising a power to exclude the employee from benefit (if such a power exists in the trust).
(d) When is a relevant life policy suitable?
A relevant life policy is suitable for those employers who, perhaps because of the smaller size of their business, do not wish to set up group arrangements (EGLPs) for all their employees, or wish to provide additional death benefits to be paid through a discretionary trust on the death of specific individual employees to their families.
A relevant life policy is also suitable when the employer wishes to add further tax-efficient benefits to existing death-in-service arrangements.
(e) When is a relevant life policy not suitable?
A relevant life policy will not be suitable if:
- The life to be insured is not an employee (eg is a partner)
- It is intended to provide death benefits beyond the employee’s 75th birthday and/or beyond the period of employment, or
- It is intended to provide benefits other than just death and terminal illness/disability/ill-health benefits.
(f) Can an employer effect a policy on the life of an employee who is a substantial shareholder?
To be treated as a relevant life policy, there must be an employer/employee relationship. Directors of a company, including shareholding directors, are also treated as employees for this purpose. However, care should be exercised if it is intended to establish a policy on the life of a substantial shareholder. This is because, in such cases, HMRC can be expected to give closer consideration to the question of whether the policy has been effected for a tax avoidance purpose, which would contravene one of the relevant life policy conditions. Particular care should be exercised in cases where it is intended to effect a relevant life policy (which gives several tax advantages) to replace an existing life policy that has none of these tax advantages. Care should also be taken with regard to business succession/protection arrangements to provide funds to buy out a deceased shareholder’s shares on his death. It is not recommended that such arrangements are set up as relevant life policy plans (although technically it may be possible to do this).
Partners, LLP members and sole traders are not employees, so a relevant life policy could not be effected on their lives. Of course, the partners in a partnership or LLP members could effect an EGLP under trust for the benefit of their families.
2.5 A summary of the benefits of a relevantlife policy
The following are the main benefits:
- No assessment of premiums on the employee as a benefit in kind or otherwise (but see 1.1(a)
- No assessment on the employee or employer for the purpose of National Insurance contributions
- Benefits are paid free of income tax
- Benefits/premiums do not count towards the lifetime allowance/annual allowance for pension purposes
- In most cases, benefits are paid free of IHT
- Potential for tax relief for the employer on premiums paid.
As the lifetime allowance continues to affect more people, relevant life policies/EGLPs will become more and more attractive as a means of providing tax-efficient lump sum death benefits for the families of higher-paid employees and partners. However, in order to be eligible for the tax benefits, it is important that all of the conditions are duly satisfied.