Financial protection

The main tax of relevance to life assurance policies is income tax. The factor that has the most significant influence on the tax treatment of a life assurance policy is whether the way that the policy is structured renders it as qualifying or non-qualifying. Generally, qualifying plans are n...

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...00 and most providers withdrew from the market for life assurance based regular savings.

Different qualifying rules apply to different types of policy:

Term assurance - The rules relating to term assurance are outside the scope of R05

Whole of life

Endowments

Exempt policies

For a whole of life assurance policy to be qualifying, the following criteria must be met:

The policy must pay out a capital sum on death (or on death/earlier disability) and only a limited range of other permitted benefits, such as waiver of premium

Premiums must be payable annually or more frequently for at least 10 years (or until earlier death or disability occurs)

The total premiums in any1 year period must not be more than double the premiums paid in any other 1 year period or exceed more than 1/8th of the total premiums payable over the whole term (or the first ten years where premiums are paid throughout life)

The total premiums in any 1 year period must not exceed more than 1/8th of the total premiums payable during the first ten years of the polic...

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...ded in the deceased’s estate and assessable for IHT. If the policy is for the benefit of someone else, for example, written in trust, the premiums are classed as a transfer of value for IHT purposes. The gift annual allowance of £3,000 per annum, and gifts out of normal expenditure from income exemption mean that, in most cases, will not be exempt transfers, rather than potentially exempt transfers or chargeable lifetime transfers. Care should be taken to ensure that these allowances and exemptions are not being used for other IHT planning purposes and are available in respect of premiums paid to life assurance policies.

What is the highest additional rate of tax a policyholder may have to pay on a chargeable gain?

Answer : Purchase course for answer

An endowment is a life assurance policy that combines protection benefits with an investment element. Traditionally used as a method of funding repayment of an interest-only mortgage or simply for regular savings these arrangements are now legacy products.

The qualifying rules for endowment assurances are as follows:

The policy must pay out a capital sum on survival of life assured to the end of the term or on their earlier death or disability

Other benefits may be included, except those of a capital nature, payable before death, disability or maturity – s...

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...T) purposes and the gain is calculated as follows:

Proceeds – (purchase price + expenses + premiums paid)

Where the result to this calculation is positive the gain would be subject to CGT in the normal way. The annual exemption and any unused losses can be offset against the gain. Any remaining amount not dealt with in this manner is then added to the individual’s other earnings for the tax year and the gain would be taxed at the applicable rate of CGT.

What is the qualifying rule in respect of the sum assured?

Answer : Purchase course for answer

When the insurance company receives life assurance premiums they will be invested within funds of the policyholder’s choosing. The tax treatment of life assurance funds is complex. For UK based life offices the effect is that tax is paid at 20% on rental income and interest. Expenses can be set against income before tax is calculated. No tax is due on dividend income (whether from UK or overseas assets) and gains realised on disposal of assets are subject to corporation tax at a rate of 20%.

Chargeable gains are taxed as savings income. When a chargeable event leads to a chargeable gain, the gross gain is ad...

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... can use any unused balance of the starting rate band

Basic rate taxpayers pay tax at 20%

Higher rate taxpayers, including basic rate taxpayers moved into the higher rate tax band as a result of addition of a chargeable gain, pay tax at 40% on the full gain

Additional rate taxpayers need to pay tax at 45% on the full gain

As for onshore policies, top slicing relief can reduce the amount of a gain subject to the higher and / or additional rate of income tax

What rate of tax is deemed to have been paid within the fund of an onshore (UK based) life assurance policy?

Answer : Purchase course for answer

The qualifying rules are amended in respect of the tax exempt life assurance policies provided by friendly societies:

Policies are subject to a maximum annual premium of £270 or £25 per month

Any premiums paid to a friendly society plan count towards the annual £3...

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...5% of the total premiums payable, where the life assured was 55 or over at outset this requirement is adjusted in the same as for non-friendly society policies

What qualifying rules apply to friendly society plans in respect of premium payments?

Answer : Purchase course for answer

Pension policies are not within the chargeable gains regime applicable to life policies. When pens...

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... subject to income tax. Income tax is deducted by the provider at the appropriate rate under PAYE.

Any changes made to the basic terms and conditions of a policy and alterations made during the term can affect the qualifying status and potentially incur immediate or future tax liabilities. Care should always be taken when advising on existing policies.

Premium loadings

Where a life office has placed a medical loading on a policy that has been fully underwritten on the basis of medical evidence, the additional premium payable is not subject to the 75% rule. This is also the case for any loading added for frequency of payments.

Backdating

A policy can be backdated for up to three months and be regarded as starting on the date to which is has been backdated to. If the policy is backdated for more than three months the start date will be the date the policy was formally completed.

This could result in the plan becoming non-qualifying as a consequence of the 1/8th rule, in respect of premiums payable in any one year, being broken as a result of more than one year’s worth of premiums being paid during the first year.

Lapsed Policies

Where a policy has lapsed through non-payment of premiums, the plan can be reinstated within the first 13 months without affecting the plan’s qualifying status; subject to a requirement that policyholder has exactly the same policy as they had before.

Any reinstatement will be subject to a requirement that the life assured provides eviden...

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...in circumstances other than those listed above- the policy will become non-qualifying if any of the policy beneficiaries are in breach of the £3,600 premium limit..

Assignments of the following types from 6 April 2013 will cause a policy to become a RRQP if any policy beneficiary is in breach of the annual £3,600 premium limit:

As part of a divorce settlement/dissolution of a civil partnership

As a result of a court order

Between husband and wife or civil partners

Into or out of a trust

To enable policy providers to determine whether a policy which otherwise meets the qualifying criteria, has become non-qualifying or a RRQP, all beneficiaries must give a written statement to the provider within three months of the occurrence of:

A policy being issued on or after 6 April 2013

A policy is varied to increase or reduce the premium-paying period or the premiums are increased or reduced (whether the policy was issued before or after 21 March 2012)

A policy assigned after 6 April 2013, except in the case of the allowable assignments (see previous topic)

The inheritance of a policy following the death of a beneficiary

Where notice is not provided with three months, the policy will become non-qualifying.

How do additional premiums due to medical loadings affect the qualifying rule in respect of the maximum level of premiums?

Answer : Purchase course for answer

There are complex rules in place regarding the treatment of changes to qualifying polices. A substitution means the replacement of an existing policy with a new one whilst a variation involves a change to the structure of a policy that continues to run. Depending on the circumstances, a new policy might be qualifying, non-qualifying or restricted relief

A significant variation may change the qualifying status of a policy, changes HMRC regards as ‘insignifican...

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...tion.

An offshore policy, issued by a non-UK life office cannot be certified and will not qualify until either:

The life office becomes UK authorised and premiums are paid to a UK office; or

The policyholder becomes UK resident and the life fund underpinning the policy is chargeable to UK corporation tax

The rules specifying whether a change to an existing life policy are significant or insignificant are detailed by?

Answer : Purchase course for answer

A non-qualifying policy, or a qualifying policy that has become non-qualifying may be subject to tax when a specific event, a chargeable event, occurs. A chargeable event may trigger a charge to income tax if giving rise to a ‘chargeable gain’. NOTE - the terminology of ‘chargeable gain’ is also used in the context of capital gains tax, to denote the profit arising on disposal of an asset; with regard to life assurance policies, chargeable gains are relevant to income tax.

When can a c...

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...m if sooner, or if the policy has been made paid-up during that time.

The applicable time limits run from inception or the date of any variation that results in an increase in premiums. Assignments by way of a mortgage or between spouses / civil partners who live together are ignored.

Premiums on a RRQP exceeding the annual premium limit may also trigger a chargeable event.

In respect of a qualifying life policy, death and maturity will only be chargeable events if?

Answer : Purchase course for answer

The occurrence of a chargeable events may give rise to an income tax liability, but only where the chargeable event creates a chargeable gain. Gains are calculated as follows:

Event

Calculation

Death

(Surrender value immediately before death + any relevant capital payments) LESS (Premiums paid + total gains on any previous chargeable events)

Maturity or full surrender

(Maturity or surrender proceeds + any relevant capital payments) LESS (Total premiums paid + any previous chargeable events)

Assignment

(Sale proceeds + any relevant capital payments) LESS (Total premiums paid + any previous chargeable events)

Relevant capital payments are any capital sums paid out by the policy prior to the chargeable event (e.g. regular withdrawals). The tax rules applying to life assurance policies allow for up to 5% of the amount paid in to be withdrawn each policy year without any immediate liability to income tax; rather income tax is deferred and account taken of such withdrawals when a chargeable event occurs at a later date. Such 5% withdrawals are treated as a return of capital invested and, therefore, not subject to an immed...

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...al allowance and does not enable the personal allowance to be otherwise reinstated.

Adjustment for restricted relief qualifying policies (RRQPs)

These policies are taxed on a part qualifying and part non-qualifying basis. Up to the date it becomes an RRQP it is taxed on a qualifying basis and from that date, the qualifying basis only applies to the balance of the annual premium limit now used up by other qualifying policies.

Tax is calculated in the normal way as for a non-qualifying policy, with relief then applied from the formula of:

Gain x ­(total allowable premiums / total premiums payable under the policy)

For example, a gain has been made of £15,000. The total premiums are £105,000 and the allowable premiums are £80,000. The relief on the gain will be:

£15,000 x (£80,000) / £105,000) = £11,428

£11,428 of the gain will be allowable and the remaining £3,572 (£15,000 - £11,428) will be deemed a chargeable gain potentially liable to income tax.

How is any chargeable gain calculated on death of the life assured?

Answer : Purchase course for answer

Where a gain arises on a policy that is held in a relevant property trust there are several factors to take into consideration when considering who is liable to pay any tax:

Trustees pay the tax where:

At least one of the trustees is UK resident

The chargeable gain occurs in a tax year after the tax year in which the settlor died, or ...

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...y the tax where:

The trustees are not UK resident

The tax will be added to their other taxable income and tax payable accordingly; they are not able to claim top-slicing relief

A chargeable gain arises on a policy held in trust in the tax year that the settlor dies. Who is liable to pay the tax?

Answer : Purchase course for answer

One of the most important tools for inheritance tax p...

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...of these areas, as discussed in the following topics.

In administering the estate of a deceased person, one of the main issues facing the legal personal representatives is submitting tax returns to and settling tax liabilities with HMRC. Estates valued in excess of the available nil rate band (£325.000 2024/25) are liable for IHT, at a rate of 40% (on the portion of the estate in excess of the nil rate band). The rate is reduced to 36% where at least 10% of a net estate is donated to charity. A complication is that any IHT must be paid before the estate can be released to the beneficiaries. This can often cause problems as the assets the deceased legal personal representatives want to use to pay the tax are the deceased’s estate.

In summary, the legal personal representatives of a deceased person’s estate would have to complete the following:

Provide an account of the deceased’s estate to HMRC

Pay any IHT due in full within six months from the end of the month in which the person died, i.e. if they died in January 2024, the tax would be due to be paid by 31 July 2024

It may be possible to pay IHT in instalments but only if the assets in the estate meet certain criteria specified by HMRC

The legal personal representatives of the deceased cannot obtain a grant of probate or letters of administration until the tax account has been settled. As they have no grant, they cannot prove title and the...

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...no way of knowing the value of assets, the nil-rates bands and the rates of tax that will be in force at that time. Methods for selecting a sum assured can include:

Calculating the IHT liability in today’s terms using current values and rates of tax assuming the tax was payable immediately

Selecting a policy that includes an option to change the sum assured (within limits) at a future date on guaranteed terms without further medical should the IHT liability significantly increase

Consider including indexation so that the sum assured increases automatically. This can be linked to RPI, NAE or a fixed amount. This would ensure that the purchasing power of the sum assured is maintained

Premiums paid to fund an IHT plan on this basis are considered as lifetime gifts but would normally be exempt under the £3,000 annual gift exemption or the normal expenditure from income exemption.

In summary, a whole of life policy written in trust would provide a cash payment outside of the deceased’s estate which would be available immediately. The liquid funds could then be used to pay any inheritance tax due, allowing a grant to be obtained and the estate released much more quickly, avoiding any forced sale of assets.

What is the deadline for the personal representatives of a person who died in September 2024 to pay IHT?

Answer : Purchase course for answer

In respect of IHT, every individual has several annual exemptions and allowances which are lost if not used. Whole of life plans written in trust can be used to receive regular payments, effectively reducing the value of the estate over time.

Each premium is treated a gift for IHT purposes, so the amount paid should be calculated carefully to ensure that no lifetime charge to IHT is incurred. This could be achieved by using:

The £3,000 annual exemption – everyone has their own allowance, so married couples a...

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...00,000.

The maximum regular contribution they could make within the annual exemptions available would be:

Neil surplus income 

£10,000

Helen surplus income 

£ 2,000

2 x annual exemptions from cash

£ 6,000

Total

£18,000

Over 10 years this would remove £180,000 from the estate, a potential IHT saving of £72,000. (£180,000 x40%)

What is the current annual gift exemption in respect of IHT?

 

Answer : Purchase course for answer

An effective way of mitigating an IHT liability is for an individual to give away assets during their lifetime, to reduce the value of the estate that would be liable to IHT on their death.

Outright gifts of cash or other tangible assets are usually classed as potentially exempt transfers (PET’s) and do not carry an immediate liability to IHT. However, if the donor does not survive seven complete years from the date of the gift, the PET is said to have failed and value of the gift, together with that of any other gifts made in the seven year period preceding death, counts towards the nil-rate band applicable at the date of death.  

The value of such gifts in excess of the nil rate band is chargeable to IHT at death rates. The amount of tax due can be reduced by the application of taper relief. The rate of taper relief gradually increases the longer a person lives into the seve...

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...dash; £325,000 NRB) @ 40% = £170,000

After 7 years the nil-rate band is available again as the PET falls out of the 7 year cumulation.

Taking the example above, James could take out a seven-year level term policy written in trust for the benefit of Amy to ensure that she had access to liquid funds to pay the additional tax arising as a result of the loss of the nil-rate band during the 7 year period following the PET. The additional IHT liability arising is: £325,000 x 40% = £130,000. A level term plan is appropriate as the PET fully uses the nil-rate band for the next 7 years, meaning that the additional IHT payable is a level amount, assuming there are no changes to the nil-rate band.

What relief can be used to reduce the amount of IHT payable in respect of a PET where the donor dies within seven years of making the gift?

Answer : Purchase course for answer

When someone dies without a will, they are said to be intestate and their estate will be distributed according to the laws of intestacy, which vary depending on which part of the UK they lived in when they died and what, if any, family members they have.

England and Wales

Where the deceased leaves a spouse or civil partner but no children or remoter descendants - the spouse or civil partner inherits everything.

Where the deceased leaves a spouse or civil partner and children or remoter descendants:

The spouse or civil partner inherits all jointly owned property, personal chattels and receives a statutory legacy of the first £322,000 of the balance of the estate absolutely plus half of any amount above £322,000 absolutely

Children inherit the remaining half of the excess over £322,000 absolutely, held in trust until they reach age 18

For many in this situation, distribution under the intestacy provisions may not be aligned with what they would have wanted.

In most cases, if someone remarries any previous will is automatically r...

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...ah’s death the NRB is £325,000

The proportion of Fred’s NRB remaining unused is applied to the NRB applicable in the tax year of Sarah’s death

The NRB available to Sarah therefore is her own NRB plus the proportion of Fred’s NRB which was unused, this is £650,000 (£325,000 + (£325,000 @ 100%) = £650,000)

In addition to the main nil-rate band, the residence nil-rate band (RNRB) was introduced in April 2017. The amount is £175,000 in 2024/25 and can be used when a main residence is passed to direct descendants on death, thus reducing the cost of IHT on a family home. Where estates are valued at more than £2 million (after deducting liabilities but before reliefs and exemptions) the residence nil-rate band will be withdrawn at a rate of £1 for every £2 over the £2 million threshold. The percentage of the RNRB remaining unused on first death of a spouse / civil partner can be transferred for use on the later death of the ‘survivor’, in the same way as the NRB can.

This revision test (opens in a ne...

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...test will be added to your CPD certificate.