A Relevant Life Policy is an alternative way for an employer to set up life cover for an employee in a tax efficient manner, without using a registered death in service group scheme.
It is set up on a single life basis and is suitable for small businesses that might not normally be able to access this type of Death in Service cover.
Relevant Life Policy Suitability
A relevant life policy is suitable for an employee of any type of business, including a director of a limited company, provided that they are a Schedule E tax payer. However, it is not suitable for a partner or sole trader who is taxed under Schedule D.
Relevant Life policies are suitable in three main situations:
1. Small businesses that do not have enough employees to warrant a registered group life scheme.
Group life providers will not usually offer schemes for businesses that have less than five employees, and even if they were willing to do this, for legislative reasons they cannot offer a registered scheme on a single life basis. This means that many small businesses are effectively excluded from taking advantage of those benefits enjoyed by larger businesses.
Because relevant life policies can be written on a single life basis, all businesses can be covered.
2. Certain high earning employees who may exceed the pension lifetime allowance.
Registered group schemes come under pensions legislation, and this means that any lump sum benefits paid on death are added to the employee’s pension funds when calculating the maximum allowance an individual can accumulate during their lifetime (currently £1.25million 2015/16). If this allowance is exceeded there is a tax charge of 55% on the excess.
Relevant life policies are non-registered schemes. This means that they do not count towards the pensions lifetime allowance, thereby avoiding this tax. Some high earners may have exceeded the limit before the legislation was introduced in 2006. They were allowed to protect the amount in excess of the limit to avoid the charge, but as a result they could not contribute any further amounts to their pension. Becoming part of a registered death in service scheme would count as a further contribution, so a relevant life policy can be particularly useful for this type of employee.
3. Members of group life schemes who want to top up their benefits. Some group life schemes have very restrictive rules with regard to the amount of benefit that can be provided. They can also have restrictive definitions of remuneration, often discounting overtime, bonuses and dividends. A relevant life policy can be used to top up these benefits in a tax efficient way.
The Tax Advantages Of Relevant Life Policies
When an employer is considering death benefit for an employee, it is important to consider the cost of the premium and the true cost of providing for it.
Premiums are paid by the employer, but are not normally treated as income in the hands of the employee, for example, a P11D benefit. Provided that the plan qualifies as a relevant life policy, by meeting the legislative requirements, there will be no charge to Income Tax for the employee in respect of the premiums.
This also applies to National Insurance, which will not be due by the employer or employee in relation to the premium, where the plan qualifies as a relevant life policy.
The employer may be able to claim tax relief on the premiums as a trading expense of the business. The local inspector of taxes would need to be satisfied that the premiums were part of the normal remuneration package of the employee and would therefore qualify under the “wholly and exclusively” rules.
As a relevant life policy is not a registered group life scheme, premiums do not form part of the employee’s annual pension allowance, but this also means that Corporation Tax relief on contributions is not guaranteed in the same way as a registered group life scheme.
The example below illustrates the effect of taxation on the true cost of providing the same net premium, depending on how cover has been arranged. The first plan is owned by the employee, with the employee paying the premium from their net (post-tax) income. The second plan is a relevant life policy.
|Employee-owned and paid plan||Relevant life policy|
|Total company net cost||£1,570||£800*|
|Company gross cost|
|Income Tax @ 40%||£690|
|Employee’s National Insurance contribution @2%||£34|
|Employer’s National Insurance contribution @13.8%||£238|
|Total company gross cost||£1,962||£1,000|
|Company net cost|
|Corporation Tax relief @20%||£392||£200*|
* For the purpose of the example, it has been assumed that Corporation Tax relief at 20% has been granted under the ‘wholly and exclusively’ rules.
The example assumes a premium of £1,000 each year to provide death benefit on the life of an employee who is paying Income Tax at 40% and employee’s National Insurance at 2% on the top end of income. We have also assumed that the employer is paying Corporation Tax at the small profits’ rate of 20% and will pay employer’s National Insurance at the contracted in rate of 13.8%.
Tax Treatment of Premiums for an Employee-Owned and Employer-Paid Life Policy
If the employee owns the plan and the employer pays the premium, the payment by the employer will be treated as the employer meeting a pecuniary liability of the employee. This is where the employee has entered into a contract, which involves the payment of premiums, but the employer meets the cost on behalf of the employee. Therefore, the employee is liable to both Income Tax and employee’s National Insurance contributions on the premium.
To provide the total cost of the plan, the amount of tax and National Insurance payable on the premium must be taken into account. The employer will usually be able to treat the gross cost as a trading expense, whether paid as salary or if the employer has paid the premium. Tax treatment of premiums for a relevant life policy The employer will own the plan and pay the premium. No Income Tax or National Insurance liabilities arise – if the plan meets legislative requirements to qualify as a relevant life policy. Provided that the local inspector of taxes accepts that payment of the premium has been incurred ‘wholly and exclusively for the purpose of trade’, the employer may be able to claim Corporation Tax relief on the premium.
Benefits paid on death do not form part of the employee’s lifetime pension allowance.
Benefits paid to the employee’s dependants through a discretionary trust, known as the ‘relevant life policy trust’, will not involve an Income Tax charge for the employee.
Benefits paid to dependants through a relevant life policy trust will be outside of the business, meaning the employer will not be subject to Corporation Tax or Income Tax.
Benefits paid through the relevant life policy trust do not form part of the estate of the deceased employee and are therefore generally free of Inheritance Tax. Because the relevant life policy trust is a discretionary trust, it will be subject to the normal Inheritance Tax treatment applicable to discretionary trusts, known as the ‘relevant property regime’. In certain circumstances the following charges can arise:
Up to 6% of the value of the trust fund in excess of the nil rate band (£325,000 2015/16), on each tenth anniversary of the date the trust was established. A periodic charge will only apply if there is a value within the trust at a tenth anniversary. This could happen if, for example, the employee dies shortly before a tenth anniversary and the benefits have not been distributed to the beneficiaries.
Up to 6% of the value of the trust fund, on transfer of benefits out of the trust to a beneficiary. The actual tax charge may be less than 6%, as the rate of tax paid will depend on how many quarters have elapsed since the last periodic charge.
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