Learning Outcome 2 Chapt 9 & 10

Question 1

REGISTERED PENSION SCHEMES

Contribution rules

Answer 1

Employees/self-employed people aged under 75 can contribute up to 100% of their earnings to their pension scheme each year & receive tax relief

Combined employer & employee contribution up to an annual allowance are allowed with no adverse tax consequences (£60,000 max)

People with little or no earnings can contribute up to £3,600 a year and qualify for basic rate tax relief

Any unused annual allowance from the previous three tax years can be carried forward and added to the annual allowance for the current tax year, however the allowance is based on the threshold applicable to those years

Question 2

Money Purchase Annual Allowance

Answer 2

If an individual start to take money from a defined contribution pension pot, the amount that can be contributed to their defined contribution pensions while still getting tax relief on might reduce.

It is currently £10,000

it is not triggered if only a pension commencement lump sum (PCLS) is taken (without any flexi access drawdown) or if a non-flexible annuity is taken.

Question 3

Death benefits from defined contribution schemes

Answer 3

Death benefits from defined contribution schemes paid on deaths occurring before aged 75 are tax free.

Benefits must either be paid out or designated to drawdown within 2 years of the date of the death to retain tax free status or the benefits will be subject to income tax under PAYE in the hands of the recipients

For death occurring on or after aged 75, any lump sum death benefits or death benefits payable as an income are subject to income tax under PAYE in the hands of the recipient

Question 4

Defined Contribution Pension Income Options

Answer 4

Funds can be crystalised with 25% of the fund available immediately as a tax free PCLS. The remainder of the fund can be withdrawn as flexi-access drawdown whenever an investor wishes. Drawdown is treated as income and is subject to the normal rates of income tax for the year of drawdown

Funds can be left uncrystallised. Withdrawals can then be taken directly from the fund, with 25% of each withdrawal tax free and the other 75% subject to the normal rates of income tax. The is known as an uncrystallised fund pension lump sum.

After taking a 25% tax-free PCLS an annuity can be purchased. This pension income is subject to the normal rates of income tax.

Question 5

Pension scheme Investment rules

Answer 5

A single set of investment rules applies to all types of pension scheme.
Investments in residential property (with a few exceptions) and in tangible movable assets – e.g. antiques, art, jewellery and fine wine – may trigger penal tax charges.

Borrowing to fund property purchase or any other investment cannot exceed 50% of the net value of the fund.

Pension funds are free of UK tax on investment and chargeable gain

Question 6

Protected and guaranteed (structured)
equity products

Answer 6

Depending on the choice of product, an investor can receive either income or chargeable gains.

An advantage of having chargeable gains is that the investor can make use of their annual exempt amount (£6,000 for 2023/24), thereby sheltering some gains from tax.

Some products will roll up the return and pay out at the end of the product’s term. This means that any tax liability is postponed, which could be useful if a lower rate of tax is expected to be payable for future years

The use of the CGT annual exempt amount could be maximised by investing in a series of products maturing in successive tax years
* Structured products can also be held within ISAs or self-invested personal pension schemes (SIPPs), with the result that all investment returns will be tax free.

Structured products are generally illiquid investments because of their fixed-term nature, but this can make them useful for IHT mitigation if an investor does not expect to live for much longer.

Question 7

Tax Vehicles used for Registered Pension schemes

Answer 7

Offshore and Onshore Insurance Bonds

Close Ended Investment Companies - These issue special classes of shares and are based in offshore financial centres i.e. Dublin, Income is treated as dividend income, subject to the £1,000 dividend allowance. Dividend tax applies i.e. 8.75%, 33.75 & 39.35%.
Chargeable gains are subject to CGT in the normal way.
Investments can be held in ISAs

Listed bonds or medium term notes - Fixed term contracts issued by UK or EU Banks
The income is taxed as savings income so any available part of the £5,000 starting rate band for 2023/24 can be used against the income, which will be taxed at 0%
The personal savings allowance is then available. This is £1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers.
After that, basic-rate taxpayers are taxed at 20%, higher-rate taxpayers at 40% and additional-rate taxpayers at 45%
Chargeable gains are subject to CGT in the normal way
They can be held in an ISAs

Question 8

ISAs Overview

Answer 8

Anyone aged 16+ can have a cash ISA

Anyone aged 18+ can have a stocks and shares, innovative finance and/or LISA

An ISA cannot be assigned or placed in a trust

Question 9

ISAs - Death of investor

Answer 9

If an ISA holder in a marriage or civil partnership dies their ISA benefits can be passed on to their spouse or civil partner via an additional ISA allowance (known as an additional permitted subscription)

The surviving spouse or civil partner may invest an amount in an ISA up to the value of their spouse or civil partner’s ISA savings at the time of death without it counting against their normal ISA subscription limit. The deceased spouse or civil partner’s ISA savings become a continuing account until the administration of the estate is complete, the ISA is closed or three years and one day have lapsed since death, whichever is sooner. If higher, the value at the point the ISA ceases to be a continuing account can be invested rather than the value at the date of death.

Question 10

ISA Taxation

Answer 10

All income and chargeable gains are free of tax and do not have to be declared on a tax return. However, investments may suffer foreign withholding taxes.

Interest received on bond investments are tax free

All ISA encashments are free of income tax and CGT

All reporting to and reclaims from HMRC are undertaken by the ISA manager. ISA investors have to supply their National Insurance number, if they have one

Question 10

Collectives i.e. Unit Trusts, OEIC, Investment Trusts

Answer 10

They can be bought and held by individual investors or within tax wrappers i.e. pensions ISAs and other funds.

They are taxed as direct investments but with some exceptions

The taxation of dividends from OEICs and equity unit trusts is the same as the taxation of dividends on shares i.e. 8.75%, 33.75% and 33.39%

Income from non-equity unit trusts, and OEICs that invest in fixed-interest securities is taxed as savings income and paid gross

Gains on disposal of unit trust and OEIC shares are liable to CGT and losses are allowable

Question 11

Reporting funds (offshore collectives)

Answer 11

A fund can apply to HMRC for what is known as reporting status. Reporting status will be granted when a fund reports details of all its income to HMRC

UK investors must be told of their share of the fund’s income when it arises so that they can include this on their self-assessment tax returns. There is no need for the fund to distribute any income

UK investors are subject to income tax when it arises whether it is distributed or not

Equity distributions are taxable at the divided rates and are eligible for the £1,000 dividend allowance

Interest distributions are taxed at the 0% starting rate, 20%, 40% & 45% . The personal savings allowance is available
Any profit on the eventual encashment is subject to the normal CGT rules and will be taxed at a rate of 10 and/or 20%

Question 12

Non-reporting funds (offshore collectives)

Answer 12

• Any fund that has not obtained reporting fund status is a non-reporting fund
  
  • Any income that accrues to the fund is usually accumulated. Income is not taxed as it arises, only on disposal of units/shares.
  • The gain (called an offshore income gain) on any disposal, including on the death of the investor, is calculated on CGT principles (without the annual exempt amount), but is subject to income tax in the tax year of encashment. Any income that has been accumulated will constitute part of the gain
  • Because the gain is liable to income tax it is charged at the 20% basic rate, the 40% higher rate or the 45% additional rate. The personal savings allowance, the dividend allowance and the starting rate for savings income cannot be used against the gain

Question 13

Offshore Funds

Answer 13

• If an offshore fund invests in equities, the dividends it receives will usually be subject to a
  non-reclaimable withholding tax.
• Fixed-interest funds are usually more tax efficient for UK-resident investors because
  these funds choose investments, such as Eurobonds and exempt gilts, which pay
  income gross.
• Some jurisdictions levy a small amount of tax on offshore funds

Question 14

Life Policy

Answer 14

Life company taxation:
Essentially, the fund pays tax at 20% on interest income, property rental income and offshore income gains.

UK dividends are generally exempt from tax.

If the fund sells any assets at a profit, it pays tax on any gain at 20% (with no relief given for inflationary increases arising from January 2018 onwards as a result of indexation allowance being frozen at December 2017).

These taxes are paid directly by the life office, so do not involve the policyholder and cannot be reclaimed by any policyholder.

Policy holder taxation:
Income tax as savings income on policy profits. These are often called chargeable event gains, although they are not subject to CGT
Tax is only payable if: a chargeable event occurs; a chargeable event gain arises; and when the gain is added to the taxpayer’s other taxable income for that year, all or part of it falls within the higher- or additional-rate tax brackets. An additional tax liability may also arise if the taxpayer is entitled to Universal Credit or tax credits when the gain results in the personal allowance or married couple’s allowance being reduced or lost, or when the gain creates or increases a high income child benefit charge

Question 15

Chargeable Events for non-qualifying life policies

Answer 15

• death (if it gives rise to the payment of a benefit);
• maturity;
• surrender;
• certain part surrenders;
• policy loan; or
• assignment for money or money’s worth.

Question 16

Chargeable events for qualifying life policies

Answer 16

• If within 10 years of the policy term (or 3/4 of the policy term if sooner unless due to death or disability) there is a full or part surrender or assignment for money or money’s worth.
• On death or maturity if this occurs within 10 years of the policy term ( or 3/4 of the term if sooner) and the policy has been converted into a paid up policy during that period
• The time limits run from the start of the policy or from any variation by which premiums are increased, unless the increase is solely because of a variation in the life or lives assured when a replacement policy is issued with no other changes to the policy, or the exercise of an option
• If a loan is chargeable event, it is treated as a part surrender and the gain is calculated under the rules for part surrenders.

Question 17

Events that are not chargeable events

Answer 17

• Assignments by way of mortgage
• Assignments between spouses or civil partners living together
• Payment of a critical illness benefit
• Policy loans at a non-commercial rate of interest on a qualifying policy if they were made before 6 April 2000 by the issuing office to full-time employees for the purchase or improvement of their main residence.
  Policy loans at a commercial rate of interest if the loan was made in respect of a qualifying policy.

Answer 18

• On maturity or surrender: if the if the amount paid out, plus any earlier capital payments, exceeds the premiums paid plus the total gains on previous chargeable events. If the sum assured is payable by instalments, the amount taken for the calculation is the capital value of the instalments.
  
  • on death: if the surrender value immediately before death, plus any earlier capital payments, exceeds the premiums paid plus the total gains on previous chargeable events.
• On assignment: if the price received, plus any earlier capital payments, exceeds the premiums paid plus the total gains on previous chargeable events.

If the assignment is between connected persons, the price received is deemed to be the market value if this is higher. In this context, a connected person would include a brother, sister, ancestor or lineal descendant.

Question 19

Part Surrenders

Answer 19

• A part surrender would include a bonus encashment or a loan that gives rise to a chargeable event if it exceeds a certain limit
  
  • The legislation looks at the total part surrenders in any policy year and not at individual part surrenders.
  • It is possible to withdraw an amount equal to 5% from the policy on an annual basis without triggering a chargeable event. The 5% allowance is based on the investment amount and is tax deferred.
  • If in any year 5% is not withdrawn, it can be carried forward to the future years on a cumulative basis
  • A chargeable event only occurs if the total amount withdrawn (reckonable aggregate value) exceeds the 5% allowance or accumulated allowances (allowable aggregate amount) at the end of a policy year.

Question 20

Taxation of gains

Answer 20

• The gain is subject to the higher or additional rate of income tax, minus the basic rate. This means a higher-rate taxpayer will pay income tax of 20% (40% – 20% = 20%) and an additional-rate taxpayer will pay 25% (45% – 20% = 25%).
• As gains are classed as savings income, the personal savings allowance and the starting rate of 0% may be available when calculating the tax on a gain.
• The amount of gain subject to tax is time apportioned when the policyholder has been resident outside of the UK during the period that the policyholder was the beneficial owner of the policy. Gains are exempt from UK tax if the policyholder is not resident in the UK throughout the tax year in which the gain is made.
• When two or more gains are made in the same tax year, the gains are added together. The annual equivalent is then calculated separately for each gain and these annual equivalents are added together

Question 21

UK Life Policy Joint Ownership

Answer 21

• If a policy is owned jointly then the gain is split in the same proportion as the ownership, regardless of the person to whom the money is actually paid. Each owner is thus taxable on their share of the gain
• If the joint owners are married to each other or are partners in a civil partnership, HMRC considers that each party should be taxed on half of the gain
• If the spouse or civil partners hold the policy in unequal shares, they can make a declaration to enable them to be taxed on their actual shares.