Roderick Ramage, solicitor, www.law-office.co.uk
posted on this site on 31 December 2015
This article is not advice to any
person and may not be taken as a definitive statement of the law in general or
in any particular case. The author does
not accept any responsibility for anything that any person does or does not do
as a result of reading it.
(from my covering email to
solicitors still seek pension law advice if they see the warning words “final
salary” or “DB”, but are often more relaxed if the pension scheme is money
purchase. This is reasonable enough as money purchase schemes present fewer
risks than DB schemes, so what can go wrong? In most deals, nothing
much. But there are still traps. In my 2015 Update I warned of the
new definition of money purchase – things are seldom what they seem. This
year I tackle death in service schemes, particularly the stand-alone insured
schemes that are often used alongside straightforward money purchase schemes.
Mostly death in service (DIS) benefits
are treated as just insurance for employees, which one can pass to the
employer’s insurance broker before moving to this or that legal issue. DIS schemes come in different flavours and
have their share of legal traps.
The Finance Act 2004 defines a pension
scheme in s150 as a scheme to provide benefits (a) on retirement, (b) on death,
(c) on having reached a particular age, (d) on the onset of serious ill-health
or incapacity, or (e) in similar circumstances.
The authorised member payments defined
in s164 of the FA 2004, that are relevant to DIS schemes are those permitted by
the pensions death benefit rules in s167 and the lump sum death benefit rules
Section 167 permits pensions to be
paid the member’s dependants (defined in schedule 28 para 15) and, added by the
Taxation of Pensions Act 2014 s3 with effect from 17 December 2014, his
nominees (as defined in schedule 28 paragraph 27A) if paid as nominees’ annuity
(ib para 27AA). NB A pension for
successors (as defined in schedule 28 paragraph 27F) may be paid only if
purchased using undrawn flexi-access funds (ib para 27FA(1)(e)) so cannot be
paid from a DIS scheme.
Section 168 lists nine lump sum death
benefits, which are authorised member payments for the purpose of s164. Of these the relevant benefit in this note is
a defined benefits lump sum benefit (FA 2004 s168(1)(a): a defined benefit is a
benefit which is not a money purchase benefits (FA 2004 s152(7)), so a lump
sum, that is a multiple of an employee’s earning or a specified amount, is a
defined benefit even if provided by what is otherwise a money purchase scheme.
The classic occupational final or
average salary (defined benefit – DB) pension scheme provides all the benefits
in para 2 above or perhaps (a) or (c), (b) and (d). Typically, two kinds of DIS benefits are
provided, first a lump sum and secondly a pension. The lump sum is usually funded by an
insurance policy, although large schemes might carry the risks and fund all or
part of the lump sums out of their own resources. Pensions for dependants’ in DB schemes are
normally funded out of the scheme’s own resources in the same way as members’
pensions. If a money purchase or other
defined contributions (DC) scheme provides dependants’ pensions other than what
the member provides out of the member’s account, which is not common except in
large schemes, they are likely to be funded by insurance.
A different kind of arrangement is
made where the employer has a smaller occupational DC scheme or provides
pensions by a master trust occupational or a grouped or other personal pension
scheme. Here DIS benefits, commonly lump
sums only, are provided by stand-alone schemes funded by an insurance policy
using trust documents provided by the insurer.
– employment contract or insurance policy
The members of an occupational pension
scheme are entitled to the DIS benefit described in the scheme’s trust deed and
rules. If there is a difference between
that and what the insurer (if any) provides, the scheme (and ultimately the
employer) must fund the difference to ensure that the full benefit is provided.
This is not usually so under a typical
stand-alone scheme. Here the insurance
company’s model trust deed and rules provide that matters such as eligibility
for membership, the amount of the benefits and the conditions on which they
paid are governed by the insurance policy or subject to the insurer’s
agreement. The member’s entitlement
under the scheme is therefore limited to what the insurer pays, which can be
less that the member’s expectation.
need to have this difference drawn to their attention and should decide whether
the benefits of an insured stand-alone DIS scheme are to be those stipulated by
the insurer or by the employer. If the
former the employment contract terms, handbooks etc must make it clear that any
benefit that appears to be promised is subject to the insurer’s terms. If the latter, the employer should alter the
insurer’s standard documents to avoid ambiguity and be aware that it might have
a funding risk if a benefits is promised that is not by covered or fully
covered by insurance.
10 of the Transfer of Undertakings (Protection of
Employment) Regulations 2006 exempts from the transfer rights in an
occupational pension scheme to benefits for old age, invalidity
or survivors. DIS benefits are benefits
for survivors. Therefore, if they are
provided by an occupational pension scheme, the right to them does not pass to
the transferee. The transferring
employees, who were members of the transferor’s occupational scheme of the have instead a right to pension protection under
ss257 and 258 of the Pension Act 2004.
Pension protection is access to a scheme to which the transferee
employer pays contributions to provide a pension, but does not include DIS
to personal pension schemes do transfer under TUPE and so, possibly as an
unintended consequence of s255 of the Pensions Act 2005, do rights to DIS
benefits under a stand-alone DIS scheme.
If the transferring employees were members of the transferor’s
stand-alone DIS scheme, the transferee employer risks the “grieving widow
syndrome”, which is that an employee will die just after
completion, and the transferee will arrive at the works or office on the
following morning to be met by the grieving widow with a babe in arms wanting
to know ‘ow much she will get. The transferee will have to pay the DIS
benefit out of its own resources, unless, before completion, it had either
arranged insurance or agreed to participate in the transferor’s scheme.
pension schemes and DIS schemes are inherently discriminatory on the grounds of
age and therefore there are numerous exemptions from the age discrimination
provisions of the Equality Act 2010.
is not discriminatory for an employer to cease to provide insurance after age
65 or the state pension age if greater, so it is permissible to cease to
provide death in service insurance at that age (EA 2010, sch 9 para 14). This paragraph does not mention
trustees. BIS has stated its opinion
that, because pension schemes are part of an employer’s pay and benefits
package, the exemption for employers extends to trustees, but it is not clear
that they are exempt.
is clear is that an uninsured benefit is not within the exemption. Therefore the withdrawal of an uninsured DIS
benefit at any age is discriminatory unless the discriminatory treatment is “a
proportionate means of achieving a legitimate aim” (EA 2010, s13(2) if the
discriminating is direct and s19(2) if it is indirect). The provision of a tax favourable benefit
scheme as a means of attracting and retaining employees is probably a
legitimate aim and the fact that the age limit for favourable tax treatment is
75 years (see para 18) probably protects an employer from a claim of
discrimination for failing to provide cover as an uninsured benefit from age
75. A grey area here is the distinction
between insurance and a benefit the funding of which is underwritten by
normal insurance company’s stand-alone DIS deed and rules provides for the
employer or principal employer to be the scheme’s sole trustee with power to
appoint the trustees. Lump sum benefits
are almost always held by the trustee on discretionary trusts to be paid to
some or all of a wide class of beneficiaries.
Members are usually encouraged to sign and deposit with the trustee a
statement of her or his wishes who should benefit and to what extent or in what
proportions. The trustee must have
regard to expressions of wishes and are entitled but cannot be required apply
the benefits in accordance with it.
Employers need to be made aware of their duty to exercise this
discretion (rather than leaving it to the HR department to apply the expression
of wishes automatically) and to consider whether this is a duty that the
employer can and wishes to perform or whether to appoint trustees. The requirement for member nominated trustees
or directors applies only to occupational pension schemes.
benefits paid as pensions are subject to income tax.
is no limit on the amount that can be paid as a DIS lump sum, which is tax free
is paid on the death of a member who has not reached age 75;
is paid to a person who is not a non-qualifying person;
to extent that it does not exceed the unused amount of the deceased member’s
lifetime allowance (LTA); and
is paid before the expiry of the period of two years beginning
with the earlier of the day on which the scheme administrator first knew of the
member's death and the day on which the scheme administrator could first reasonably
be expected to have known of it.
19 A non-qualifying person is a person who is not an individual or, if an individual, receives the payment in his capacity as a trustee or personal representative, director of a company, partner of a firm or member of an LLP (FA 2004 s206(9) inserted by the Finance (No 2) Act 2015 s21(1),(5).
conditions in para 18 apply to lump sums paid on and after 6 April 2016 (FA
2004 s206(1A), (1B) inserted by the FA 2011, s65 and the Taxation of Pensions
Act 2014 s3 and sch 2, para 17) and are broadly similar to the present
definition of a defined benefits lump sum death benefit in the FA 2004 sch 29,
these conditions are not satisfied, a special lump sum death benefits charge
arises on the payment of the defined benefits lump sum death benefit (FA 2004
s206(1A),(1B). The rate of the charge is
45% of the lump sum (FA 2004 s206(4), reduced from 55% in respect of payments
on and after 6 April 2015 by the Taxation of Pensions Act 2014, s2(5)).
tax is payable if (amongst other circumstances) the trustees are bound to make
a lump sum death payment to a person nominated by the member or if they have no
discretions how the lump sum is to be applied and must pay it to the deceased’s estate. Money held on discretionary trusts for a
class of beneficiaries cannot form part of the estate for IHT.
allowance (LTA) and
DIS lump sums
amount of an individual’s LTA on 6 April 2006, when the present tax regime was
introduced, was £1.5m, which was increased until it reached £1.8m in 2010,
since when it has been reduced until from 6 April 2016 it will be £1m.
member’s LTA is tested on each benefit crystallisation event (BCE) (FA 2004,
s216), and amounts crystallised in excess of his LTA are subject to a charge to
income tax known as a lifetime allowance charge (ib s214). The charge is 55% of the amount of the excess
taken as a lump sum or 25% on the amount retained in the scheme and paid as
pension (ib s215).
as an illustration:
employee with an annual salary of £200,000 dies in service on or after 6 April
2016 and before drawing any benefits, so that the whole of his LTA is
an account worth £750,000 in a money purchase scheme, and
lump sum benefit of £800,000 (four times his annual salary): and
money purchase account is disposed of first and is disposed of as a single
designation, after which his DIS lump sum is paid as a single lump sum, the
consequences would be that
first BCE, the designation of his money purchase account will be tax free and
leave £250,000 of his LTA available, so that
the second BCE, the payment of the DIS lump sum, £250,000 will be free of tax
and £550,000 will be subject to tax.
response to that situation would be for the DIS scheme’s trustee to assess not
only who is to benefit and for how much (para 16 above) but also how the tax
will affect each prospective beneficiary and in what order and how the
distributions are to be made.
response, which could be made in anticipation of this situation, is for the
employer to investigate and decide whether or not to exclude its higher and
prospectively higher paid employees from its registered DIS scheme and to
provide for them an unregistered scheme with either or both of two kinds of
life assurance policy, which are (a) a
relevant life policy under s393B(4)(b) of the Income Tax (Earnings and
Pensions) Act 2003, which is for a single person and it transferrable to a new
employer, and (b) an excepted group life policy under the s480(3) of the Income
Tax (Trading and Other Income) Act 2005, which is for two or more employees. to
provide death in service benefits, on terms which can be broadly similar to
those of the registered scheme
significant feature of unregistered schemes with either relevant or excepted
group policies is that they are not subject to the FA 2004 and the benefits
under them do not affect and are not affected by the member’s LTA.
costs (premiums to the insurance policies) are paid solely by the employer and
there is no tax liability on the employee in respect of either the premiums
paid by the employer or the lump sum benefit, unless the schemes and the
policies are used for tax avoidance.
copyright Roderick Ramage
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