Life Insurance Policy Tax Explained
Firstly, we need to understand Life Insurance Company Fund Tax
- A life insurance company pays company tax internally on its fund. It is the insurance company that pays the taxes. After an allowance for indexation, these are normally
- Income Taxes - 20%
- Capital Gains Taxes - 20%
- These gains and tax liabilities are spread over a 7 year period. With offsets for expenses and losses, it is normally a total tax liability charge of nearer 15-18%.
Life insurance company funds also have:
- No further liability to taxes on dividends
- No further liability to taxes on net savings income, i.e. tax already deducted at source
- A 20% liability to tax on income paid gross i.e. without taxes deducted
In simple terms, life insurance company funds have already paid tax when a policyholder receives their money and it is only higher rate tax payers who may have a further liability.
What does this mean on tax to a policyholder?
- The position on tax, is about whether the policy is a qualifying policy or not.
Normally Life Insurance Death, Endowment and Critical Illness Policies
- All proceeds, including death and critical illness claims are paid tax free.
Non - Qualifying Policy:
Normally Insurance Investment Bonds and other former qualifying policies that have been sold on such as endowments that have been traded or sold. There are a number of rules:
5% Rule - 5% of the original investment can be withdrawn each year for up to 20 years, with no immediate liability to tax.
Withdrawals in Excess of 5% Rule:
There are some complex, top slicing calculations required to work out exactly how much tax is due, but broadly speaking the tax position is as follows:
When the gain "slice" is added to your gross income, you are taxed based upon the tax bracket you fall into:
- If in a Non Tax Payer Bracket - tax is deemed paid, no tax liability but cannot reclaim any taxes paid by fund
- If in Lower Rate Tax Bracket - tax is deemed paid, no tax liability but cannot reclaim any taxes paid by fund
- If in Basic Rate Tax Bracket - tax is deemed paid, no tax liability
- If in Higher Rate Tax Bracket - 20% tax is deemed paid, additional 20% marginal rate is due
- If in Additional Rate Tax Bracket - 20% tax is deemed pad, additional 25% marginal rate is due
1. Life Insurance Qualifying Rules
Life Insurance Tax Rules: Award Winning Investment Advice
Qualifying rules are rules set out by HM Revenue and Customs that will allow certain types of life insurance investment plans to pay out benefits either on death or surrender tax free.
If a life insurance investment policy is classed as a qualifying policy for tax reasons it has to fit within certain rules but, if the rules are adhered to, the proceeds of the policy will be completely tax free. The insurance company will still pay taxes on the fund whilst the policy is in force.
For a life insurance investment policy to be qualifying it must meet the following rules:
- The policy must be for a term of at least 10 years
- Premiums must be at least annual and paid for 10 years or until death.
- Life assurance equivalent to 75% of the total premiums paid must be included.
For life insurance protection policies such as whole of life, endowments or term assurance, the rules may be slightly different.
Maximum Investment Plans (MIP) or Qualifying Savings Plans (QSP)
- Maximum investment plans and other qualifying savings plans are tax free for all investors after 10 years for all policies. However as higher and additional rate tax payers were making huge investments in these savings plans, the Government have introduced premium restrictions:
- Tax Year 2013-14 - Maximum contributions limit £3,600 pa for all plans started after 21 March 2012.
Non - Qualifying policies:
- If the policy does not meet the qualifying rules, for example an insurance bond or a MIP started after 21/03/12 with high contributions, or if it was a qualifying policy but it is surrendered within 10 years or three quarters of the term (whichever is less) then it becomes non-qualifying.
- Income tax could be payable because surrender or partial surrender is a chargeable event. Tax is only payable on the gain made.
Non taxpayers and basic rate taxpayers normally will have no tax to pay.
Higher rate tax payers will have a tax liability to pay, top slicing rules determine whether or not tax is payable.
See here for investment bond taxation.