Life assurance schemes – the top 10 compliance risks employers should avoid
Many employers provide generous life assurance schemes for their employees. These schemes generally pay out "lump sum" death benefits following the death of the member in service. Typically the benefits will be provided under a life assurance policy. Many of these schemes are established under "discretionary trusts". The employer will be the "sponsor" of the scheme and often also the "corporate trustee". This can have tax advantages for beneficiaries in the event of a claim under the policy.
Life assurance schemes can be established either as tax registered schemes, or non-registered schemes where the underlying benefits will not count towards the member's lifetime allowance (which is his UK tax limit on tax relievable pension savings) which is currently £1.25 million. People with large pension pots (including people with sizeable accrued benefits under final salary pension schemes) may have taken steps to protect their pension savings by applying for special types of tax protection. The protection is against the tax penalties associated with earning pension benefits in excess of the lifetime allowance cap.
Employers should be careful to avoid compliance risks associated with these trust based life assurance arrangements. These include the following "top ten" compliance risks:-
- Tax protections for "protected employees" – these can be jeopardised where they are admitted as members of a new registered life scheme;
- Tax avoidance risks - moving people from registered to excepted policies can lead to risks where the reason for the change is to avoid tax. Advice should be sought;
- Missing documentation - the trust document is required for the trustees to administer the trust and be able to pay out the benefits free of inheritance tax. A member booklet or policy summary is not enough. Complications also arise where employers wish to amend their scheme provisions and cannot find the current documentation;
- Uninsured liabilities – there can be differences between the benefits described by the trust documents and the underlying policy. This can lead to a funding shortfall for the employer in the event of a claim;
- Employment contracts/HR policies – these can lead to further uninsured liabilities where contractual promises are greater than insured benefits. These should be reviewed;
- Choice of insurer – some historic trust deeds stipulate the insurer for the scheme, whereas in practice another insurer may now be in place. Scheme amendments will be required;
- Amendment restrictions – some historic trust provisions require the prior consent of an insurer to make scheme amendments. Further complications arise where the policy is no longer with the same insurer. Consideration needs to be given to compliance with these provisions and/or making changes to the rules;
- Notification requirements - scheme amendment powers can also contain additional requirements to notify affected persons like members and participating employers which need to be considered when changes to the scheme are being considered;
- Inadequate trust powers - additional trust powers may be required to effectively administer the scheme, including powers to establish separate children's trusts for beneficiaries following a member's death;
- Admission of group employers – where other employers in the group employ members of the scheme they too need to be formally admitted to the scheme. The form of admission will depend on the scheme rules which should be reviewed.
Where employers have old scheme documentation they should undertake a review now to protect against the risks as illustrated above. Additionally employers should ensure that the scheme documentation is reviewed periodically to keep it up to date and ensure it continues to properly reflect the provision of the intended scheme benefits.