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Taxation of life assurance policies

Taxation of life assurance policies

Written by Tina Winter

The section of the J01 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.

Image of calendarTo 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.

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

  • The policy must be on the life of the policyholder and/or spouse, the policyholder must be resident in the UK and must be with a UK authorised life office
  • 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 premiums must be paid regularly on an annual or more frequent basis such as monthly
  • The sum assured must be at least 75% of the total premiums payable over the life of the policy

There are rules that need to be considered if policies are varied, but like the man said, it’s a complex area. You now rarely come across plans that were in existence taken out before 14 March 1984, but the ones that were, which could for example be old whole of life plans, could well still qualify for LAPR which is given at source at a rate of 12.5%.

The “Qualifying Life Policy” definition is still relevant today when LAPR is very rarely an issue, because qualifying policies benefit from a much more favourable tax regime than non-qualifying policies. 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 Age Allowance, withdrawal of Child Tax Credit, or the income limits for withdrawal of personal allowances. The gain is treated as carrying a basic rate tax credit.

A Chargeable Event only occurs in the case of a qualifying policy on death, maturity, partial surrender or assignment for money’s worth if the plan was made paid-up within ten years or three-quarters of the term if sooner. 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 surrenders, 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, and we’ll look at the taxation treatment of non-qualifying policies in another article.