5 Policyholder Tax

Question 1

List five stages at which tax may be payable (or recoverable) on a life insurance policy, and indicate who would pay the tax. (5)

Answer 1

1. On the payment of each premium (policyholder).
2. On the receipt of each premium (company).
3. On receipt of investment income and gains (company).
4. On the payment of policy benefits (company).
5. On the receipt of policy benefits (policyholder).

Question 2

State five factors on which the qualifying status of a life insurance contract depends. (5)

Answer 2

1. Contract term
2. Premium paying term
3. Premium frequency
4. Relationship between premiums payable in different 12-month periods.
5. Death benefit in relation to total premiums payable.

Question 3

State the types of claim for which benefits might be taxed if an insurance contract is:
1) Non Qualifying
2) Qualifying
(2)

Answer 3

A tax charge on the benefits received by the policyholder (or the estate):

1. On death or maturity, surrender, part-surrender or sale if the contract is non-qualifying.
2. On surrender, part surrender or sale within 10 years or three quarters of the policy term if less, if the contract is qualifying.

Question 4

Where tax is payable on life insurance contract benefits, describe how the chargeable gain is calculated. (4)

Answer 4

1. The chargeable gain is the excess of benefits received over total premiums paid in.
2. On death: the chargeable benefit is taken as the surrender value immediately before death.
3. On part surrender: the benefit is the excess of the amount received over 5% per annum in respect of each premium paid.
4. On final surrender, maturity or death: the taxable amount is the total chargeable gain less what has previously been taxed. If this is negative a policyholder can claim deficiency relief.

Question 5

Where tax is payable on life insurance contracts, describe how the rate of tax is determined. (3)

Answer 5

Tax is payable on the chargeable gain at the policyholder’s marginal rate less the lower rate of income tax.

So lower rate tax payers are not charged.

40% taxpayers are charged 20% and 45% taxpayers are charged 25%.

Question 6

Describe the policyholder taxation of general annuity contracts purchased since 1992. (5)

Answer 6

1. No tax relief on premiums.
2. Tax is payable on the income component of each benefit payment. This is the total payment less the capital content.
3. The capital content is the premium divided by an expectation of life at commencement.
4. The income component is taxed at the full marginal rate of income tax.
5. Any death or surrender benefits are also subject to tax.

Question 7

Describe the personal allowance that applies to pension contributions. (2)

Answer 7

1. The personal allowance is an annual limit on an individual’s contributions eligible for tax relief.
2. It is the higher of £3600 and full taxable UK earnings.

Question 8

Describe the annual allowance that applies to pension contributions. (5)

Answer 8

1. The annual allowance is an annual limit on total (individual plus employer) contributions eligible for tax relief.
2. Currently £40k.
3. A three year carry-forward facility exists.
4. If an individual has accessed a flexible (unlimited) drawdown plan, the allowance is cut to £4k of the original’s. (Remains at £40k if the drawdown is limited).
5. The limit is also tapered down to £10k where the taxpayer’s income is >£150k.

Question 9

Describe the tax treatment of pension benefits. (5)

Answer 9

1. From age 55, 25% of benefits can be taken tax-free as a lump sum.
2. The remaining 75% can be placed into a drawdown account or used to purchase an annuity.
3. The annuities or amounts drawn down are taxed as earned income.
4. Alternatively, a series of lump sums can be taken of which 25% is tax free and the remaining 75% is taxed at the marginal rate of income tax.
5. The Lifetime Allowance is £1m, an upper limit on total tax-advantaged pension savings.

Question 10

Describe the tax treatment of pension funds on the death of the investor. (3)

Answer 10

1. If the investor dies before age 75, and unvested or drawdown funds can be passed tax-free to beneficiaries as a lump sum.
2. Alternatively, a dependent can continue with the drawdown arrangement, free of tax.
3. If the investor dies after age 75, the benefits payable to beneficiaries are subject to a tax charge.