Unravelling the Complexities of the Taxation of Life Assurance Policies – Part 1

What if you could answer CII R03 exam questions on the taxation of life assurance policies accurately and confidently? Over the next two articles, we will simplify the topic for you. In this article, you will learn about what conditions a qualifying life policy needs to fulfil and the situations when tax is charged on these policies.

The section of the R03  manual that covers this topic starts with the immortal words “the taxation of life assurance policies is a complex area”.  An understatement if ever I’ve heard one!

To fully understand what is going on here, first of all we need to delve into the past, probably to a time before most of the readers of this article had even considered that one day they would be contemplating a career in financial services, never mind studying for exams in the subject, and go back to 14 March 1984. This memorable date was when Life Assurance Premium Relief (LAPR) was abolished for new life policies.  In the case of policies taken out before that date, tax relief continued to be due for premiums paid in respect of plans that were “qualifying life policies”, and the definition is still relevant today.

What conditions need to be met by a Qualifying Life Assurance Policy?

A Qualifying Life Policy broadly needs to fulfil the following conditions:

• The premiums must be payable for ten years or 75% of the term whichever is the shorter. For example a ten year endowment plan will qualify after seven and a half years
• The annual premium must be less than 1/8 of the total premiums payable
• Premiums must be paid annually or more frequently such as monthly
• The sum assured must be at least 75% of the total premiums payable throughout the term
• Where the life assured is aged 55 or over the minimum sum assured is reduced by 2% for each year over age 55.
• Also a policy taken out on or after 6 April 2013 can only be qualifying if the premiums are within £3,600 per year

When is tax chargeable for Qualifying Life Assurance Policies?

There are rules that need to be considered if policies are varied, but like the man said, it’s a complex area. Qualifying policies benefit from a much more favourable tax regime than non-qualifying policies, so tax is only chargeable if:

• A “Chargeable Event” occurs; and
• A “Chargeable Gain” (broadly payments out less payments in) arises; and
• When the gain is added to the taxpayer’s total income for that tax year, it is in the higher or additional rate tax brackets. There are also tax consequences if the gain crosses the boundaries for considering entitlement to things such as the married couple’s allowance, child benefit and the income limits for withdrawal of personal allowances. The gain is treated as carrying a basic rate tax credit.

When do Chargeable Events occur?

In the case of a qualifying policy, a Chargeable Event only occurs :

• On death, maturity, partial surrender or assignment for money’s worth, and
• If the plan was made and paid-up within ten years, or if sooner, three quarters of the term, or if the £3,600 premium limit has been breached.

Chargeable events do not occur frequently in the case of qualifying policies; they are sometimes seen, however, in the case of Traded Endowment Policies, where the original owner of the plan sells it on rather than surrendering it, but only within the ten-year / three-quarters-of-the-term time period mentioned above. The plan becomes non-qualifying in the hands of the new owner.

We look at the taxation treatment of non-qualifying policies in this article.

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