LEARN THIS! Chapter 5 - (6 exam questions) Taxation Of Life Assurance And Pension Based Policies Flashcards
What part of a life policy can be subject to income tax or CGT?
Any investment gain
The payment of someone’s sum assured is not taxed but any investment value that has built up within a policy could be taxed
investment gains on life policies can be subject to income tax.
If the policy has been sold on the second-hand market a CGT liability may also arise.
For context
If the policy is purely protection-based, and no investment gain is likely, then there should be no income tax or CGT implications.
If it is investment-based, such as an endowment or investment bond then, potentially, there could be a tax liability for the policyholder, or their estate.
What rules do insurance policies must meet to be deemed as ‘qualifying’
Qualifying / non qualifying rules in practise
Qualifying / non qualifying rules in practise
Qualifying / non qualifying rules in practise
The basic qualifying rules change depending on the type of insurance policy
The following includes the policies individually and highlight some of their features, plus the key differences with regard to their qualifying rules.
Only an awareness of the rules covered next is required for your R05 exam. So, don’t worry too much if not much sticks…!
There are certain ‘specified events’ that can occur that causes a qualifying plan to become a non qualifying plan, and therefore, lose its tax-exempt status unless some other certain conditions are met
Be aware of these rules You dont have to know them in full detail for RO5
Extra premiums and policy debts
Any extra premiums charged due to higher risks are disregarded when considering the qualifying rules
Backdating the start date of a policy
If a policy is backdated by 3 months or less it will be treated as if it started on the earlier date. If the backdating is for a longer period, its commencement will deem to have been on the date of policy completion. This could affect premium-based qualifying rules such as the 1/8th rule, invalidating a policy’s qualifying status.
Reinstating a lapsed policy
Policies can lapse for a variety of reasons such as affordability or poor organisation. This means premiums are not paid. A policy can be reinstated and, if this occurs within 13 months of the first unpaid premium, the qualifying status of the plan will be unaffected, as long as the plan conditions and premiums are unchanged.
If the policy conditions change and/or a different premium is charged, the policy will be treated as a new one, and this can affect its qualifying status. If reinstatement does not occur within 13 months, this will have the same effect.
Substitutions and variations
The rules around substitutions are complex and varied and outside the scope of this study guide. For both substitutions and variations, when considering whether a policy can retail its qualifying status, HMRC would need to determine whether the variation is ‘significant’ or not. Also, the benefits provided by the policy would have to be approximately the same.
Changes of life assured
A change of life assured is viewed as a fundamental change by HMRC. The policy would be viewed as new and could be classed as either qualifying or non-qualifying.
Non-qualifying policies
These are policies that either fail the qualifying rules from outset, or become non-qualifying as a result of the rules being broken.
Give an example of a policy that is non qualifying from the outset
The most common type of non-qualifying policy is one where premiums are not regularly paid,
An example of this is an investment bond which is non qualifying because it is a one-off premium.
Summary
At a high level, what difference occurs in relation to taxation when a life assurance policy is onshore and when it is offshore
The taxes paid on the life fund internally by the insurer will differ
The calculation of any policyholder liabilities on any gains will differ
There are 2 differences that occur in relation to taxation when a life assurance policy is onshore and when it is offshore
These are that:
The taxes paid internally on the life fund by the insurer will differ
The calculation of any policyholder liabilities on any gains will differ
Tell me specifically about how the internal taxes that the insurer pays differs when an life policy is onshore compared to offshore
There are 2 differences that occur in relation to taxation when a life assurance policy is onshore and when it is offshore
These are that:
The taxes paid internally on the life fund by the insurer will differ
The calculation of any policyholder liabilities on any gains will differ
Tell me specifically how the calculation of the policyholders liabilities on any gains made changes if a fund is onshore compared to offshore
For context:
When comparing onshore and offshore funds is not a question of paying more tax for onshore policies than for offshore but considering who pays the tax: the insurer and/or the policyholder.
Because an onshore policy fund is taxed internally this may mean less or no direct personal liability for the policyholder. Little or no tax may be levied on an offshore based policy, which may result in higher potential investment growth (if an investment-based policy) but it may also mean a higher investor tax liability, as there is no insurer-paid tax that can be used to reduce the individual’s tax bill.
For tax to be due on a life assurance-based policy investment gain, WHAT must have occurred.
a chargeable event
For tax to be due on a life assurance-based policy’s investment gain, ‘a chargeable event’ must have occurred.
What are these different events and how do they differ for qualifying and non qualifying policies
For non qualifying policies remember: DAMPS
DEATH
ASSIGNMENT for money or money’s worth
MATURITY
PART SURRENDER
SURRENDER
For qualifying policies:
it is the same except with one extra event which is where the policy has a loan taken out against it as security. Also, Death and Maturity are only ‘chargeable events’ for qualifying policies if the policy is ‘made paid-up’ within 10 years or 3/4 of the term whichever is earlier.
NOTE: On death, the calculation of any chargeable gain is based on the SURRENDER VALUE of the policy immediately before death, not the death benefit
make sure you know the definition of ‘made paid up’
If a life assurance policy is held in trust how is it taxed?
All the same rules apply to life assurance polices in trust like they do with normal life assurance policies. Ie qualifying/non qualifying and that life assurance benefits themselves are not taxable, but the investment gains made on a policy potentially are.
Because it is held in trust however, it has the following difference:
If the settlor still alive any gains will be assed against them
If the settlor has died and one trustee is UK resident, then the gain will be assessed on the trustees.
If a life assurance policy has been sold on the second-hand market, how is it taxed?
The image is an example of a policy being sold
If a policy is sold, and it is sold for money worth, CGT could be payable by the purchaser if a gain is made on any future disposal of the policy
the way it is taxed depends on whether it is a qualifying policy or a non qualifying policy
Remember
SUMMARY
Any ONSHORE life fund of a UK-based insurer is subject to taxation and is paid at the following rates: SEE IMAGE
None of these taxes can be reclaimed by any taxpayer. Bearing this in mind ( ie how onshore bonds are taxed) why are onshore life funds not the best for investors who are non-taxpayers?
Nature of Onshore Bonds:
Onshore bonds are investment products issued by UK-based insurance companies. These bonds allow investors to invest in various funds with the insurance company managing the underlying investments.
Taxation of Onshore Bonds:
The insurance company pays tax on the investment income and gains generated within the bond at the basic rate of income tax (currently 20% in the UK).
This tax is paid by the insurer directly and is
considered when calculating the returns credited to the bond (ie they policyholder will get less)
Implication for Policyholders:
Basic Rate Taxpayer: For basic rate taxpayers, the tax paid by the insurer is treated as satisfying their tax liability on any gains. This means they owe no further tax on these gains unless they become higher or additional rate taxpayers.
Higher/Additional Rate Taxpayer: These taxpayers may have to pay additional tax if their marginal rate of tax exceeds the basic rate. They would owe the difference between the higher or additional rate and the basic rate already paid by the insurer.
Non-taxpayer: Non-taxpayers (individuals whose income is below the personal allowance and therefore don’t pay any tax) cannot reclaim the tax paid by the insurer. Even though no further tax is due from them, they can’t benefit from a refund of the 20% tax already paid within the bond.
SO basically, onshore bonds are bad for non taxpayers and good for basic and higher/additional taxpayers
How are offshore life funds taxed internally
Offshore funds are where the insurer is based offshore, such as in the Isle of Man, Guernsey or Jersey, and not in the UK. Most offshore funds are non-qualifying
The funds pays little or no tax on their funds internally. The only tax likely to be levied is a small amount of non-reclaimable withholding tax.
What is CGT?
When are life assurance based policies subject to CGT?
What is the CGT threshold?
CGT is a tax paid by UK residents on gains made ANYWHERE IN THE WORLD
The only time CGT is payable on a life assurance based policy is when an individual who is not the original owner realises the gain
Each individual is entitled to £6,000 of gains free from CGT for the current tax year but any gains above this exemption will be taxed at 10% and/or 20%
TRUE OR FALSE
In terms of IHT, estates valued at over £2,000,000 lose the RNRB allowance (Currently at £175,000) at a rate of £1 for every £2 over this threshold.
TRUE