From 6 th April 2006 scheme trustees, administrators and members must be aware that the level and type of benefits which will be permitted to be paid on the death of a member in an occupational pension scheme will change significantly. Should employers and trustees agree to amend the rules of their schemes to avail of the changes it will present many scheme members with the option of greater flexibility as well as the potential for IHT planning.
Currently scheme death in service (DIS) benefits are provided either as a fixed amount or as a multiple of salary up to a maximum of 4 times tax free. In addition a spouses (dependents) pension of up to 4/9 ths of the members salary may also be provided taxable as earned income.
It has been these Inland Revenue limits which have tended to drive the design of scheme DIS benefits rather than a desire to meet the needs of the specific scheme membership. Importantly this DIS benefit design will continue to apply unless pension scheme trustees opt for change.
From April 2006 under the Finance Act 2004 pension simplification regulations will require the payment of a lump sum death benefit from either a DB scheme, or prior to benefits being drawn from a DC scheme, to be treated as a benefit crystallisation event and therefore to be tested against the lifetime allowance (LTA) charge. The LTA for 2006/7 will be £1.5m and any lump sum death benefit payable up to this amount will be tax free with any excess subject to a recovery charge of 55%. This should provide the majority of members with significant additional scope for DIS benefits. It should also mean that it will be more attractive for members to have DIS benefits provided in a lump sum form which is tax free rather than as a spouses (or dependants) pension which would be taxable. Even if income is required it may be more attractive to provide this in the form of a purchased life annuity of which only a small proportion of the income would be taxable.
For those scheme members who’s DIS benefits are likely to exceed the LTA the recovery charge could be avoided by paying the excess as a spouses / dependents pension as these are not tested against the LTA and therefore no recovery charge would be payable. These pensions can be payable for life or until dependency ceases or may cease if dependent re-marries. They cannot be assigned, guaranteed or subject to annuity/ pension protection and can only be commuted on grounds of triviality.
All occupational schemes therefore need to review how they provide DIS benefits and should consider re-structuring benefits to more closely meet the needs of their scheme members as well as to take advantage of the more attractive new tax structure available. Trustees should also be aware that such a change is not only likely to be more attractive to scheme members but also more attractive to schemes as it removes the longevity risk.
These changes could create IHT planning opportunities and it is also not unreasonable to assume that there will be a greater demand for stand alone pension life cover given that contributions will be tax relievable unlike those payable for non pension related products. This also looks to be an area which could be ideally incorporated within new or existing flexible benefits packages.
It is not yet clear how this area of the market will evolve. Will this be provided as an option within scheme? How would cover be extended should the member leave service. Will the collection of data be difficult? How can medical evidence be policed? Also given that the benefit provided can only be as a lump sum or salary multiple within a DB scheme and that within such schemes there is no requirement for the lump sum DIS benefit only to be available before drawing pension the added flexibility likely to be required may not be as easy to accomplish as it appears.
It will be interesting to see how this area evolves over the coming months but trustees should already be consulting their advisers to identify which options are available to them and which best suit the needs of their scheme membership.
Published in the Scotsman 10 th September 2005