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Tech centre - Financial planning bulletin

Lifetime Allowance Protection and Death in Service Schemes

May 4, 2018, 16:05 PM

Summary


The lifetime allowance has reduced from its initial level of £1.5M in April 2006 to £1M from 6 April 2016. It has subsequently increased by 3% on 6 April 2016.
At the time of the introduction of the lifetime allowance in 2006, and on subsequent reductions in the allowance, protections have been available to individuals impacted.

The protection can be lost under certain circumstances and one of the causes of invalidating an election for protection that has gone partially under the radar is joining a death in service or group life scheme on or after the date of the protection. Remember that most death in service/group life schemes are UK registered pension schemes. In this article we will take a look at how membership of a death in service scheme can impact on a client’s protection from the lifetime allowance, and consider the potential advantages of a relevant life policy as an alternative.

Facts and analysis


Since 6 April 2006 there has been no limit on lump sum death benefits provided by a registered pension scheme, but they are tested against the lifetime allowance on death before age 75 (Benefit Crystallisation Event (BCE) 7) with any excess taxed at 55%.

In respect of lump sum death benefits the scheme administrator will pay the full benefit even if this exceeds the lifetime allowance and it is the recipient who is liable for tax at 55% on any excess.

Various lifetime allowance protections have been available since 2006. Primary protection and individual protection are not impacted by the continuation of, or joining a new death in service scheme. Enhanced protection and fixed protection, on the other hand can be lost in such circumstances.

  • Enhanced protection was available from 6 April 2006 with a closing date for applications of 5 April 2009. Benefits within the maximum permitted at 5 April 2006 are not subject to a lifetime allowance check when crystallised on or after 6 April 2006.
  • Fixed protection, fixed protection 2014 and fixed protection 2016 provide a protected lifetime allowance of £1.8M, £1.5M and £1.25M respectively.
  •  

    Enhanced protection will be lost in the following circumstances –

  • There is ‘relevant benefit accrual’ under a registered pension scheme
  • Joining a new pension arrangement other than in permitted circumstances
  • A transfer is made that is not a permitted transfer
  •  

    Fixed protection will be lost in the following circumstances –

  • There is ‘benefit accrual’ under a registered pension scheme
  • Joining a new pension arrangement other than in permitted circumstances
  • A transfer is made that is not a permitted transfer

 

Relevant Benefit Accrual/Benefit Accrual and Maintaining Death in Service Cover

Where an individual applies for protection and also continues membership of a pension scheme for death in service benefits only there are specific rules that apply. The rules cover contributions made on or after the date of the protection to an existing arrangement (joining a new arrangement is covered in the next section). As detailed below, the rules for contributions to a money purchase arrangement are the same for enhanced and fixed protection, but differ for a defined benefit arrangement.

1. A contribution to a money purchase arrangement will not count as relevant benefit accrual (enhanced protection) or benefit accrual (fixed protection) provided all of the following conditions are met -

  • The contribution is used to pay premiums under a policy of insurance on the life of the member
  • The insurance contract was made before 6 April 2006
  • There is no right to surrender any rights under the policy
  • The only payment under the policy is on the member’s death
  • The policy is not varied significantly to either increase the prospective benefits or extend the term of the policy between 6 April 2006 and the date of death

Please note that there are some limited circumstances where a policy can be surrendered and replaced by a new one and it can still be treated as a pre-6 April 2006 policy.

2. A contribution to a defined benefits arrangement for death benefits only is not relevant benefit accrual and will not result in the loss of enhanced protection if the lump sum death benefit does not increase at a faster rate than that applying to retirement benefits.

3. A contribution to a defined benefits arrangement for death benefits only will not result in the loss of fixed protection because it is not classed as benefit accrual.

This means that continued membership of a DB death in service scheme will not normally impact on enhanced or fixed protection so long as the member joined the scheme before the protection commenced. Where the death in service scheme is a money purchase arrangement more care needs to be taken to ensure that the cover started prior to 6 April 2006. The good news is that the vast majority of death in service schemes are DB arrangements. Where the lump sum is expressed as an amount by reference to salary, service or some other factor it will normally be a DB arrangement. Where the lump sum is expressed as the proceeds of the policy it will normally be a money purchase arrangement.

Joining a new pension arrangement

Protection is lost on joining a new pension arrangement unless it is made in permitted circumstances as follows –

  • For the purpose of receiving a permitted transfer
  • As part of a retirement-benefit activities compliance exercise, or
  • As part of an age-equality compliance exercise

For example, David ceases active membership of his pension scheme on 5 April 2016 and applies for fixed protection 2016 (FP2016). David subsequently changes employers and his new employer enrols him into the company death in service scheme as part of the terms or service for his new job. The death in service scheme is established as a UK registered pension scheme, and hence David’s FP2016 will be lost from the date of joining the scheme.

Relevant life policies

Where a member holds enhanced or fixed protection a relevant life policy may be a very suitable alternative. A relevant life policy is an individual policy and is not a registered pension scheme. This means that the life cover can be arranged for the member without impacting on their protection, and any benefits paid are not tested against the lifetime allowance.

The main points about relevant life policies are –

  • Contributions are paid by the employer
  • And are normally treated as a business expense for corporation tax purposes
  • Contributions are not normally taxed as a benefit in kind for the member
  • The benefits are normally paid free of tax
  • The scheme is set up under trust with the employer as the settlor
  • The only benefit payable is a lump sum, which is payable to the family and dependants of an employee if they die in service before retirement age, and can be paid to the employee on diagnosis of a terminal illness
  • Some arrangements now also offer critical illness cover for the member
  • Benefits are paid at the trustees discretion and are not normally subject to inheritance tax
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Next Steps


Care needs to be taken with clients who have applied for enhanced and fixed protection to ensure that their protection is not lost. The main circumstances to look out for are –

  • Joining a new death in service scheme after the start date of their protection other than in permitted circumstances
  • In the case of a money purchase death in service scheme where membership commenced after 5 April 2006, continuing membership after the start date of protection will result in the loss of enhanced and fixed protection
  • In respect of enhanced protection, continued membership of a DB death in service scheme will result in the loss of protection if the lump sum death benefits increase at a faster rate than that applying to retirement benefits

Relevant life policies have similar tax benefits to a registered pension scheme but will not cause the loss of any protection. Even for those without protection they may be a very suitable alternative because any death benefits are not tested against the lifetime allowance.

Learning outcomes and reflective questions for CII accredited CPD


Reading this article can count towards structured CPD under the CII CPD Scheme if you consider the Learning Objectives below to be directly relevant to your own personal professional development plan. The Reflective Questions don’t require answering, they are aimed to help you reflect on the issues raised in the article for your reflective statement on your CPD Certificate.

Learning objectives:

  • To list the protections that can be affected by continued death in service
  • To understand when relevant benefit accrual and benefit accrual occurs as a result of continued membership of a death in service scheme
  • Understanding when a client can join a new death in service scheme without losing their protection
  • How relevant life works, and why it could provide a solution for those with protection

Reflective questions:

  • Can my client continue membership of their death in service scheme if they apply for protection?
  • Can my client join a new scheme providing death in service benefits only and maintain their protection?
  • Would relevant life provide a suitable alternative to a death in service scheme?

Important information


The information contained in this article has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2018. It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice. Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients. You should always seek appropriate legal or other professional advice.

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