Update on the taxation of life insurance policies

In the May 2016 issue of WHIB we reported on the government’s consultation on the taxation of life assurance policies. The consultation considered how the current rules on part surrenders of life insurance policies should be amended to prevent excess tax charges arising on some occasions and three possible options for change were put forward.

The problem with the current rules

The problem with the current rules (which tax part surrenders made in excess of 5% of the original policy premium), is that they can lead to an excess charge to tax if a large withdrawal is made in the first years that the policy is held. This is because the gain then chargeable to tax is calculated by reference to the amount withdrawn in excess of the 5% deferred allowance and this is likely to have no reference to the actual gain on the policy at that time. For example,  if an individual paid a single premium of £50,000 for a policy, a withdrawal of £20,000 a year after the policy was taken out would lead to an assessable gain of £17,500 which is highly likely to be in excess of the actual economic gain on the policy.

The results of the consultation

These were published on 5 December 2016. The preferred option for most respondents was the proposal that the current cumulative 5% tax deferred allowance should be changed to a lifetime 100% deferred allowance. Once all premiums paid have been withdrawn, withdrawals would be taxed in full so the assessable gain would equal the economic gain.  This option was considered to be the easiest to explain to policyholders, the simplest in terms of transitional arrangements and the cheapest to implement. All options were, however, considered to require expensive changes to IT systems. It was also pointed out that industry changes, including improved policyholder support and education, has meant that the number of disproportionate gains have been reduced substantially.

The government’s decision

Given the reduction in the number of affected cases, the government has decided that a change for all policyholders is no longer appropriate but they have stated that they would like to help the few taxpayers affected by disproportionate gains chargeable to tax.

To achieve this, draft legislation has been published which it is intended will be included in the 2017 Finance Bill. The legislation will enable policyholders who have made disproportionate taxable gains to apply to HMRC and request that their gains are recalculated on “a just and reasonable basis”. This is intended to come into effect from 6 April 2017.

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