Unravelling the Complexities of the Taxation of Life Assurance Policies – Part 2

What if you could answer CII R03 exam questions on the taxation of life assurance policies accurately and confidently? Our last article set out the conditions that make a life assurance policy qualifying, and in this article, we will explain non-qualifying policies. 

To state the totally obvious, if a life assurance policy isn’t qualifying, then it is non-qualifying.

The Main Conditions of a Qualifying Policy

As we discussed last week, these are the main conditions that make a policy qualifying:

• the term;
• regular premiums;
• premium amount; and
• level of life cover compared to the premiums paid.

Non-Qualifying Policies

This means that all offshore policies are non-qualifying by default, and also that non-qualifying policies will often be set up as a wrapper for investments, rather than purely to provide life cover. Single premium investment bonds, both onshore and offshore, are therefore non-qualifying.

Onshore Non-Qualifying Policies

Looking at onshore non-qualifying policies first, the major occasions which give rise to chargeable events are:

• Death, if it gives rise to a benefit;
• Maturity;
• Surrender;
• Partial surrender over certain limits – cumulative 5% of single premium per policy year;
• Policy loans after 26 March 1974; and
• Assignment for money or money’s worth.

It is a fairly comprehensive list and covers pretty much every occasion where funds are realised from the policy. The gain arising on the chargeable event arising on maturity or surrender is calculated by deducting from the amount paid out the premiums paid and the total gains on previous chargeable events. On death, the surrender value immediately before death is substituted for the amount paid out. On assignment, the price received is substituted for the amount paid out, or market value if the transaction is between connected persons. The gain is then added to the policy owner’s total income for the tax year and, if appropriate, is subject to the higher or additional rate of tax, minus the basic rate, to allow credit for life company taxation.

When Top Slicing Comes Into Play

If adding the gain to the policyholder’s other taxable income for the year means that their top rate of tax is moved up a bracket to higher or additional rate, then the dreaded (by exam candidates!) top slicing relief comes into play. The calculation involves the following steps:

• Divide the gain by the number of full years the plan has been in force to get your top slice
• Work out the tax on the top slice which, as the name suggests, is treated as the top slice of income for the tax year
• Multiply the tax on the top slice by the number of full years the plan was in force – this is the maximum tax payable on the gain, so the full tax liability calculated on the entire gain less this figure is your top slicing relief. If the top slice falls fully within the basic rate band, there will be no additional tax due.

Offshore Policies

Offshore policy gains are calculated in a similar fashion but with no credit given for basic rate tax, as the offshore life company hasn’t paid UK tax on its income and gains.

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