Avoiding the 10 year anniversary tax risks in British death in services schemes

However, the advantages of these schemes came with a complication because they are not exempt from inheritance tax like a registered pension scheme would be. This primarily becomes an issue at, and after, the 10 year anniversary, meaning that unexpected liabilities can arise without appropriate planning.

An excepted group scheme is a means of providing death in service cover in a tax-efficient way without using a pension scheme, with the main benefit being, historically, to avoid higher earning employees accidentally triggering lifetime allowance charges. That is no longer applicable, but there is still a significant advantage because sums paid under an excepted group scheme don’t count towards the lump sum death benefit allowance, which can otherwise impose significant tax charges on higher earning employees if they have significant pension savings and a high multiple is used in calculating the death benefit.

The 10-year anniversary issue

Broadly, there is a risk of triggering an inheritance tax (IHT) charge at the 10-year anniversary. These schemes are set-up as trusts which hold the insurance policy, and as such they are subject to the special IHT regime which applies to other trusts because there is no exemption like there is for pension scheme trusts. The rules are complex, but that can result in an IHT bill of up to 6% of the trust fund and potentially further charges every time a payout is made over the following 10 years.

The issue can arise if there are payouts from the insurance which are yet to be distributed, which can easily happen because it can take months to exercise the trustee’s discretion in less straightforward cases. It could also arise if there are terminally ill employees at the 10-year anniversary. In either case, there could be, or be deemed to be, value in the trust which exceeds the employer’s ‘nil rate’ band of £325,000. This still applies even if the insurer is holding the funds pending a decision on payment by the trustee.

Solving the issue

There are various options to solve the 10-year anniversary issue, but one way is to replace the trust before the 10-year anniversary. If done properly and sufficiently in advance, that should minimise and potentially avoid the anniversary charge, although there are tricky issues around management of any terminally ill employees, which would need to be considered and worked through if applicable. Additional considerations may also arise if the employer is a ‘close’ company for tax purposes.

It may also be a good opportunity to update and modernise the trust terms, and if the excepted scheme is currently only used for higher earning employees, consideration could also be given to the pros and cons of covering all employees through the one scheme going forward.

For subscribers to a provider’s master trust, whereby they act as trustee, the above issues are less of an immediate concern because the provider will have primary responsibility for sorting out the necessary compliance. Despite this, it is important to understand what they propose, noting that any IHT liability is likely to ultimately fall to the employer or be deducted from payments under the master trust terms, and what the implications may be.

The first step is to discuss the particular circumstances of your trust with a specialist legal advisor, who can then determine and advise on the most appropriate course of action and what needs to be put in place.