8: The tax treatment of protection policies

Question 1

Do contributions to life assurance attract income tax relief?

Answer 1

No

Unless for certain term assurances set up under the terms of a personal or stakeholder pension

Question 2

Life policy benefit proceeds are recevied upon death. When else might they be received?

Answer 2

If the policy has an investment component (Whole-of-life):
* On Maturity
* Surrender
* Part- Surrender

Question 3

Who pays any tax ude on the gains and/or income received from investmends made with a polciyholder’s money?

Answer 3

The life office

The life office pays corporation tax on income and CGT on profits made on assets sold.

This means that any basic‑rate tax liability on the behalf of the individual has already been met by the life office.

Question 4

Qualifying and non‑qualifying policies - What does this mean?

Answer 4

Qualifying policies
* Meeting certain requirements, are entitled to beneficial tax treatement
* This means that the policy holder does not pay any additional tax (to what has already been paid by the life office - i.e. basic rate tax) on gains made

Non-qualifiying policies
* Policies in which the proceeds may be taxable
* The tax dues is a special form of tax related to income tax.

Question 5

Qualifying policy rules - for policies with a term of ten years or less (4 points)

Contribution limits covered in another card

Answer 5

• The policy must secure a capital sum on death or earlier disability and no other benefits (a cash sum upon maturity of endowment is allowed).
• ‘Other benefits’ excludes capital benefits upon disability, waiver of premium benefit,
  surrender values and increasing cover options.
• Any surrender value the policy provides cannot be of an amount greater than the
  premiums paid.
• Policy term must be at least one year.

Question 6

Qualifying policy rules - for policies with a term of ten years or less (5 points)

Contribution limits covered in another card

Answer 6

• Premiums must be payable at least annually
• Total premiums in any 12 month period must not be greater than twice the total any 12 month period
• Premiums must be payable for at least ten years or three-quaters of the term or until death if less
• Total premiums in any 12-month period must not exceed 1/8th (12.5%) or the total premiums due to be paid over the term.
  For whole‑of‑life policies this is based on the total premiums payable in the first 10 years if premiums are payable throughout life
• The sum assured must not be less that 75% of the total premiums payable up to the life assured’s 75th birthday or maturity (for endowments)

Question 7

Qualifying policy rules - Contribution limit rules

Answer 7

• As from April 2013 - Maximum annual premiums of £3,600
• Policies before March 2012 are referred to as Restricted Relief Qualifying policies (RRQP)
• If multiple policies are in tandem, the policy that takes the total contributions over £3,600 will be classified as non-qualifying.
• Any gains arising from contributions in excess of the £3,600 limit will be subject to
  chargeable gains taxation

Question 8

Taxation of non-qualifying policies - Chargeable events

4 points

Answer 8

For non-qualifying policies, the policy becomes taxable in the hands of the policyholder if the gain arises from a chargeable event:

• On surrender of the policy (before 10 years or 3/4 of policy term if less than 10 years)
• Death of policy holder
• On maturity
• On assignment of the polic for money or money’s worth (selling the policy)

Question 9

Non-qualifiying policies - how is the gain calculated?

Answer 9

Amount received less premiums paid

Unless in the case of death, where the relevant amount is deemed to be the surrender value immedfiately before death less the premoums paid - this may be significantly less that the death benefit paid out.

Question 10

Taxation of qualifying policies - The taxation of policyholders - nil-rate, basic rate, higher rate, additional rate taxpayers.

Answer 10

• Basic rate tax is deemed to have already been paid by the life office
• Policyholder’s pay the excess - so if higher rate, they pay 20% and additional rate pay 25%
• Non-taxpayers cannot reclaim tax deducted

Question 11

What is top-slicing relief? How is it calculated?

Answer 11

An event where a taxpayer (below additional rate) in addition of a chargeable gain from a life policy makes them a higher or additional-rate taxpayer

Top-slicing is used to determine how much additional tax is due on the gain.

Part of gain is added to their income for the current tax year - this is the top slice and is calculated by dividing the gain by the total number of years the policy has been in force

If all or part of this top slice, when added to the policyholder’s other income, falls into the higher‑rate tax band, the tax due on the top slice is calculated as 20 per cent of that part falling into the higher‑rate band. This figure is then multiplied by the number of complete years for which the policy has been in force to obtain the tax due on the whole gain.

In calculating eligibility for the personal savings allowance, the whole gain, not the top slice gain, is added to taxable income.

Question 12

The process to calculate tax liability on a chargeable gain - 9 steps

Answer 12

1. Chargable event?
2. Chargeable event led to chargeable gain? (Proceeds exceed premiums paid)
3. Yes -> Top slice gain = Proceeds less premiums divided by number of full years policy in place.
4. Add top-sliced gain to taxable income
5. Now in Higher-rate band?
6. If No, no additional tax due
7. If Yes, calculate how much income is above higher-rate threshold
8. Multiply this amount by 20%
   9. Multiple the value of step 8 but the nu,ber of full years for which the plan has been in force

Question 13

The tax treatment of withdrawals from a life policy

Answer 13

• 5% of the money paid into a life policy may be withhdrawn each year without giving rise to an immediate income tax allowance.
• This allowance may be carried forward in whole, or in part, to future years

Question 14

Withdrawals from investment based life policies above the 5% rule?

Answer 14

• Amount over the 5% is taxed at 20% for a higher rate taxpayer, 25% for an additional rate taxpayer
• Note - The gain may be top-sliced before tax is applied
• Note - the 5% allowance can be carried forwards from previous unused years.

Question 15

e

Taxation of term assurances

Answer 15

• Term assurances are pure protection - no investment component:
• No Surrender value
• No CGT
• No Income tax relief on premiums (Unless part of pension plan before Dec 2006)
• Benefits from term assurance are tax free - unless used to provide an income, in which case, they may be taxed.
• IHT is due where the benefit is added to the individual’s estate and exceed their nil-rate bands

One way around this when a term assurance is used to provide a replacement income is to use an FIB plan that pays the sum assured asincome in tax‑free instalments.

Question 16

Avoiding taxation on term assurance benefits used to provide an income?

Answer 16

Use a FIB plan that pays the sum assured asincome in tax‑free instalments.

Question 17

Tax treatment of contributions to pension term assurance

Answer 17

• No longer available to new customers since 2006
• Plan could not exceed the member’s 75th Birthday
• Could only be single-life
• Up to Dec 2006 contributions to pension‑based life assurance were eligible for
  tax relief

Question 18

Tax treatment of lump‑sum death benefits from a pension

Answer 18

Death pre-75
* Benefits paid tax free so long as under LTA and within 2 years of death

Death post-75
* Taxable at marginal rate of income tax.

Question 19

Tax treatment of offshore life policies - What is an offshore life policy?

Answer 19

An offshore life policy is one issued by a life assurance company resident outside the UK.

Such a policy is classified as non‑qualifying
* If the UK arm of a overseas company issues - not classed as offshore

Question 20

Taxation of funds and benefits from an offshore life policy (7 points)

Answer 20

• The life funds underlying an offshore policy are not subject to UK life fund taxation.
• If the funds are invested in assets in countries where the income and or gains are
  taxed, then this tax may not always be recoverable.
• Double taxation arrangements mean that tax will not be paid twice – that is, once in
  the UK and once in the country in which the income or gains arose.
• For UK residents, tax will not be payable until proceeds arise (that is, until a
  chargeable event occurs).
  The gain can be reduced according to the amount of time, during the life of the plan,
  for which the policyholder was non‑UK resident.
• Taxable gains will be charged at basic and, if appropriate, higher‑rate tax unless the
  life company has already been taxed at a rate of at least 20 per cent – as long as the
  policy was insured by a life office in the European Union (EU) or European Economic
  Area (EEA).
• If tax on gains and income has already been levied at a rate of at least 20 per cent,
  the only potential additional liability is for higher‑rate income tax (again, as long as
  the policy was insured by a life office in the EU or EEA).

Question 21

The taxation of life policies arranged for business
protection

Answer 21

• the policy is short term (policy term does not exceed the usefulness of the insured
  to the business);
• the policy is set up to protect against the loss of profits only;
• the policy has no surrender value; and
• there is an employee/employer relationship.

If criteria are not met - the premiums are not tax‑deductible, but the proceeds will not be charged to corporation
tax unless they fall within the chargeable event rules.

Question 22

Pg 137-138

Question 23

Life assurance and IHT - How to mitigate? Tax due?

Answer 23

• IHT may be due where the benefit from the life assurance policy is paid to the policyholder’s estate and takes them above any nil-rate band allowances
• One common way to mititgae this is to write the benefit in trust (This also allows for speed of access as probate does not need to be granted for the beneficaries to obtain fund)

Question 24

Premiums paid into a life policy arranged under trust - IHT and tax? Existing policy then placed into trust?

Answer 24

• Premiums paid towards a policy in trust are classified as a gift
• They are normally exempted by various allowances (annual exemption and gifts out of normal expenditure)
• If a policy was not initially set up in trust, it can be put in one, however, this will be a chargeable lifetime transfer if a discretionary trust is used
• If no surrender value and holder in good health, the open market value of the policy may be negligible for IHT purposes - can be cancelled out by exemptions.
• If a Bare/absolute trust is used, the transfer will be a potentially exempt transfer, and so long as the policy holder survives for 7 years after the transfer is made, there will be no IHT due

Question 25

Life policies in trust - benefits? Costs?

Answer 25

* Benefit paid to estate - outside for IHT * Period and exit charges may apply when the capital leaves the trust

Question 26

Taxation of critical illness cover (CIC) - Individual plans

Answer 26

* No tax relief on premiums; * Claim made for insured conditions covered is **free of tax** * Some policies may be non‑qualifying, which means that payment on death or surrender may be classed **as a chargeable event.**

Question 27

Taxation of critical illness cover (CIC) - Group plans. What happens if premiums are not a benefit in kind

Answer 27

* The **employer can claim the premiums as an allowable business expense**; * It is possible to structure the scheme so that premiums paid by the employer are not taxable as a benefit in kind in the hands of the employee, but this means that the proceeds will be taxable in the event of a claim; and * The majority of schemes are set up to ensure that benefits are paid under trust, which means that **there is a tax charge on employer contributions** but **no tax charge in the event of a claim.**

Question 28

Taxation of income protection insurance (IPI) - indiviudal plans

Answer 28

* No tax relief on contributions * Benefits not subject to tax

Question 29

Taxation of income protection insurance (IPI) - Group plans

Answer 29

* Employer contributions are **tax deductable** * Benefits from group schemes are payable to the employer and are taxed as a trading receipt. * The employer passes the benefits on to the employee as earnings (tax‑deductible for the employer) and **they are taxed in the employee’s hands as earned income.** * Employer contributions are not taxed as a benefit in kind for employees

Question 30

Tax treatment of ASU and MPPI plans

Answer 30

* **No tax relief** on contributions * Benefits are **paid tax free** * **Insurance premium tax **is payable on contributions to a personal ASU plan. * Employer contributions are a benefit in kind and **set against corp tax**

Question 31

Tax treatment of (PMI) schemes

Answer 31

* Premiums are subject to** insurance premium tax;** * **Benefits are paid out tax‑free.** * Employers who contribute to PMI on behalf of their employees- **allowable deduction against corporation tax.** * Employer contributions are classed as a **taxable benefit in kind.**

Question 32

Tax treatment of hospital cash schemes

Answer 32

* Premiums are subject to insurance premium tax. * Benefits are **free of tax.**

Question 33

Tax treatment of illness or accident policies summary - list all that policies that pay benefit **tax-free**

Answer 33

* Individual IPI * Individual CIC * Individual and Group PMI * Individual and Group ASU

Question 34

Tax treatment of illness or accident policies summary - list all policies where benefit is** taxable**

Answer 34

* Group IPI * Group CIC - subject to scheme design

Question 35

Tax treatment of illness or accident policies summary - list all policies where premiums **attract no tax relief**

Answer 35

* Individual IPI * Individual CIC * Individual PMI * Individual ASU

Question 36

Tax treatment of illness or accident policies summary - list all policies where premiums can be set against **corporation tax**

Answer 36

* Group IPI * Group CIC - subject to scheme design * Group PMI * Group ASU

Question 37

Tax treatment of illness or accident policies summary - list all policies where premiums attract a **benefit in kind charge for employees **

Answer 37

* Group PMI (Potentially * Group ASU (Potentially) * Group CIC (Potentially - based on scheme design) ***No benefit-in-kind charge on employee***

Question 38

The Anderson principles - life policies are only considered tax-deductible if they adhere to these **4** qualities:

Answer 38

* Short term * No surrender value * The policy is set up to protect against the loss of profits **only** * This is an employee/employer relationship

Question 39

Monthly premiums of £50 are paid for an death benefit of £150,000 which has been put in trust. For inheritance tax purposes, how would this policy would most likely be treated?

Answer 39

* An exempt gift - Annual premiums fall below the annual exempt amount * otherwise, it would be a PET.