The tax treatment of a life assurance policy benefit depends on whether or not it is a qualifying policy and how the benefits are drawn.

Qualifying Policies 

Criteria

• The term of the policy must be at least ten years; 
• Premiums must be payable annually or more frequently for at least ten years (or until death, or disability); 
• The minimum level of life assurance cover is 75% of the total premiums payable; 
• Premiums payable in any one year must not be more than double those payable in any other year; 
• No premium is to be more than one eighth of the total premiums payable over the term of the policy;
• For policies issued since 6 April 2013, the annual limit for premiums payable under qualifying policies that are not exempt is £3,600 in a 12 month period.

Taxation

• A surrender within the first ten years, or three-quarters of the term if sooner, can be subject to income tax because it is a chargeable event (the policy becomes non-qualifying): Tax is payable only if the surrender value exceeds the total gross premiums (the chargeable gain) and then only at the saver’s top rate minus basic rate.
• The proceeds of a qualifying policy on maturity are completely free of any further annual taxes: There will be no income tax or CGT if the policy is in the hands of the original life assured and it meets the qualifying criteria.

Non-Qualifying Policies

All gains on non-qualifying policies are taxable. However, tax is only payable if:

• A chargeable event occurs; 
• A chargeable gain arises; 
• And/or when the gain is added to the taxpayer’s total income of the year, it is in the higher or additional rate tax bracket. 

What is a Chargeable Event?

• The chargeable events for non-qualifying policies are: 
• Death of the life assured; 
• Maturity; 
• Surrender or final encashment of a policy; 
• Certain part surrenders;
• Assignment for money or money’s worth 

When a chargeable event occurs a calculation (as follows) must be done to calculate the chargeable gain

• Partial withdrawals – Determined at the end of the policy year to see if all withdrawals have exceeded the 5% tax deferred allowance. If not, the tax is deferred and the remaining allowance can roll over to following years.
• Maturity, surrender or assignment for money or money’s worth – The gain is assessed in the tax year in which it occurs and taking into account all previous chargeable events and withdrawals, minus the original investment and previous chargeable excesses.
• Death – When the bond is payable on death, it is calculated as if the bond had been cashed on the date of death. 

Use the examples in the study text to put the above knowledge into practice as this is how it will be tested in the exam.

How is this gain taxed once calculated?

• The top-slice of the gain is calculated and added to the individual’s income for that tax year. (top-slicing is a method of splitting the gain over the number of years the policy has run to minimise the gain – the way that it is calculated is beyond R02).
• Provided taxable income, including the top-slice, is not more than the basic rate threshold in the year the bond is cashed, no personal tax would be payable. Non-taxpayers cannot reclaim any tax.
• Tax is charged at the difference between the higher rate and the basic rate on the amount falling in the higher rate band (20%) or
• Tax is charged at the difference between the additional rate and the basic rate on the amount falling in the higher rate band (25%).