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Simplifying Group Life to close the protection gap

 

It is a funny old world where your simplest product confuses the distributor and customer!

A Group Life lump sum benefit simply pays out on the death of an employee and the payment to survivors is not subject to Inheritance Tax as it is outside of the employee’s estate. Nothing else needs to be said, surely?

Regrettably it does. With only 4% of employees understanding the name Group Life Assurance and 37% preferring either Employee Life Insurance or Death Benefit,[1] we really need to align and get the name of this simple benefit understood. Not a great start, but it gets worse. There are further complexities within the product which need explanation.

On the death of an employee a lump sum benefit (either a fixed amount or a multiple of salary) is paid by a trust to the employee’s beneficiaries, which sounds simple enough – you need a trust to ensure you get the best tax outcome. However there are two versions of this ‘simple’ product, both written under a trust:

 

  • Registered Group Life – benefits count towards the Lifetime Allowance
  • Excepted Group Life – benefits do not count towards the Lifetime Allowance

 

As 2018 started, group risk insurers had 8.345 million people covered under Registered schemes and a further 782,000 people covered under Excepted schemes; around 9.12 million people in total insured for Lump Sum death benefits. Excepted cover has increased dramatically in recent years, from 2,877 schemes in 2013 to 7,130 in 2017.[2]

Why are there two versions? And what does the Lifetime Allowance have to do with a death benefit? Group Life schemes have been aligned with pensions legislation and taxation for many years, as Approved and then Registered schemes. “A Day” introduced the Lifetime Allowance back in 2006, which affects many more people in 2018 than it did at launch. It has reduced to £1.03m from £1.8m in 2006 and Defined Contribution (DC) pension pots and wages have increased. Benefits in excess of the Lifetime Allowance are taxable at 55% and so, where this is exceeded on death, a tax charge on beneficiaries is payable.

As an example, if an employee has DC pension savings of £800,000 and a lump sum benefit of £600,000, their total “pension” is £1,400,000. That gives them £370,000 in excess of the Lifetime Allowance of £1,030,000, which is taxable at 55% – the beneficiaries end up with a bill of £203,500! Not only is this a shock to survivors, it becomes more complex where there are multiple beneficiaries.

 

In addition, joining a Registered scheme may put pension protections such as Fixed Protection or Enhanced Protection at risk. It is difficult for the employer, employee and their advisers to assess when or whether this will happen as there is likely to be an advice gap. There is a lack of clarity about whose responsibility is it to tell the employee. Their personal financial adviser may not be aware of the death benefits or their format, the Trustees may not know about the employee’s previous pension pots and the employer has no obligation to provide any advice.

As a result of being outside of the Lifetime Allowance, it is easy to understand why Excepted Group Life schemes have significantly grown in popularity. Delinking death benefits from the pension fund makes perfect sense. But that is too simplistic a view as Excepted schemes are provided in complex trust vehicles which have periodic and entry charges and restrictions on the policy structure such as single benefit amounts. It is always a good idea for employers to take specific legal and tax advice before setting one up, so all are clear about what the Trustee’s obligations are and how any reduction in benefits paid would impact on an employer’s contractual obligations.

It is estimated that UK businesses may have paid as much as £24m to establish and manage Excepted schemes to date, for less than £1m tax return to the Treasury in 2014/15, the latest figures available. Lobbying to simplify the regime is underway via the industry’s trade bodies.

 

In essence there are 3 simple options to simplify and make Group Life simple:

  • Remove lump sum Registered Group Life from the pensions taxation and legislation regime
  • Simplify Excepted Group Life trust requirements
  • Remove the Lifetime Allowance, allowing all employers to use a Registered scheme. This may happen as part of a wider review of tax and pensions. If the Lifetime Allowance is retained, it could be excluded from death benefit calculations before age 75.

 

The main benefits of simplifying this regime are:

  • Clarity for employers and employees about what death benefit amounts will be.
  • Reduced burden on businesses, particularly SMEs, through reductions in running costs for employers and insurers as a single lump sum product with less reporting would be used.
  • Little or no impact on tax receipts and a clear pensions simplification initiative.

 

Of the 1.8m UK employers that could have this benefit,[3] only 43,700 Registered schemes exist.[4] 98% of organisations have no death benefits! Unless we simplify our offer and have one easy to implement trust vehicle which retains all the current tax benefits, then perhaps this market will never grow to its full potential.

 

[1] Canada Life Product Clarity research, Q4 2017

[2] Swiss Re Group Watch 2018

[3] https://www.limitedcompanyhelp.com/how-many-limited-companies-uk/

[4] Swiss Re Group Watch 2018

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Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

Canada Life International Limited and CLI Institutional Limited are Isle of Man registered companies authorised and regulated by the Isle of Man Financial Services Authority.

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Stonehaven UK Limited and MGM Advantage Life Limited, trading as Canada Life, are subsidiaries of The Canada Life Group (U.K.) Limited. Stonehaven UK Ltd is authorised and regulated by the Financial Conduct Authority. MGM Advantage Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority.