Standard Life Protection & Healthcare Ezine

Standard Life's Protection & Healthcare newsletter for advisers

September 2006

LITR is an efficient way of providing life cover that receives tax relief on the payments, with the resulting lump sum payable on death during the term generally free of tax.

Why the caveat of 'generally'? Well, to allow for the tax relief on payments, LITR is established under pensions' legislation and because of this the Lifetime Allowance will have an effect.

What does this mean in practice?

On death, any lump sum paid out by the contract will need to be tested against the deceased's available Lifetime Allowance.

The Lifetime Allowance is the limit on tax efficient pension benefits, and every time someone crystallises a pension (i.e. vests a pension contract), then the value of their pension and any tax-free lump sum will use up a proportion of their Lifetime Allowance. Any lump sum paid out on death will also be classed as a crystallisation event and use up the Lifetime Allowance, though any pensions paid out on death to dependants do not count towards the Lifetime Allowance.

The Lifetime Allowance starts off in the tax year 2006/2007 at £1.5 million.

So care needs to be taken when taking out cover under LITR, as other pension benefits might have an effect on the amount that could be paid out on death, tax-free.

Anyone over the minimum pension age (currently age 50, increasing to 55 from 6 April 2010) could vest any pension they have subject to scheme rules allowing. This crystallisation would use up some of their Lifetime Allowance. Any pensions already in payment before the date the new regime commenced (A-Day - 6 April 2006) will also use up Lifetime Allowance, though the amount is not determined until the first crystallisation event after A-Day.

Example

Monica Grand is aged 54 in the 2006/2007 tax year, but is already in receipt of a pension from an employment she left at age 50. The pension in payment is currently £12,600 per annum. She also has a Self Invested Personal Pension (SIPP) worth £100,000, and an Executive Pension Plan (EPP) worth £300,000.

Monica decides she wants the tax-free lump sum from the SIPP, so she vests that contract, taking 25% as a lump sum (£25,000) and putting the residual fund of £75,000 in income drawdown (known now as unsecured pension). She doesn't need any more income so she sets the level of drawdown at zero.

The amount crystallised by vesting the personal pension is the value of any tax-free lump sum plus the amount put into the unsecured pension. So £100,000 of the Lifetime Allowance is used up.

As this is the first crystallisation event after A-Day, a value has to be put on the pension in payment. This is achieved by using a factor of 25 and multiplying it by the current annual level of pension in payment. For an annual pension of £12,600, the crystallised amount is £12,600 x 25 = £315,000.

So in total, £415,000 of the Lifetime Allowance is used up.

If Monica wished to effect life cover using LITR, then care should be exercised when determining the amount of cover that could be established which would not breach the Lifetime Allowance.

So what scope is there for life cover?

For example, if Monica died within the 2006/2007 tax year, then assuming that the remaining EPP pays out its fund value of £300,000 on death, then that would have used up £715,000 in total of her Lifetime Allowance (i.e. £415,000 + £300,000), leaving £785,000 remaining.

If Monica only needs life cover of £500,000 then she has plenty of scope, but if she needs cover of £800,000, then the Lifetime Allowance would be breached on death within the 2006/2007 tax year. Once the Lifetime Allowance is used up, any lump sum paid out would be subject to a tax charge of 55%, known as the Lifetime Allowance Charge. However, if the amount above the Lifetime Allowance is used to provide dependants' pensions (provided there were some dependants) then the charge is avoided, though the pensions would be subject to income tax at the recipient's marginal rate.

LITR does offer an option to convert to a conventional term assurance product on a like for like basis if the Lifetime Allowance is in jeopardy of being exceeded. This option is free of charge and is automatically included within every plan. This may be of use to Monica if she takes out LITR with a sum assured of £500,000 and the value of her other pensions increase by a lot more than anticipated over the next few years. Monica could use this option if her total pension benefits were within 90% of her Lifetime Allowance. The new payment charged on conversion would be the equivalent of the gross LITR payment at inception.

So when setting the level of cover through LITR, the amount of the client's available Lifetime Allowance should be considered. For further information, please see:

Numbers 1, 2 and 5 of our Pension Benefits briefing cards PDFs -

For more technical information, please visit the Techzone area of the adviserzone.