Financial protection

The most important fact to es...

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...ing in certain circumstances.

Benefit payments are treated as capital payments and are always free of income tax providing that they remain “qualifying”. Qualifying status is gained by achieving certain criteria, as follows:

Where the term is for less than 10 years

The term must be for at least one year

The policy must secure only a capital sum on death or earlier disability and no other non-permitted benefits

Permitted 'other' benefits are participation in profits, annuity options, increasable options, waiver of premium, disability benefits of a capital nature and surrender values 

Any surrender value must not exceed premiums paid

W...

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...efit is. If the policy was written on an ‘own life’ basis and not in trust, the death benefit will be included in the deceased’s estate. If the policy is for the benefit of someone else, for example, written in trust, the premiums are classed as a transfer of value for IHT purposes. However, as the amounts for term assurance are comparatively low, there are exemptions (such as the annual £3,000 gift allowance) which will mean the premium will be an exempt transfer.

Why is it unlikely that income tax would be payable in the event of a death claim from a non-qualifying term assurance plan?

Answer : Purchase course for answer

For a whole of life assurance policy to be qualifying, the following criteria must be met:

The policy must pay out a capital sum on death (or on death/earlier disability) and no other non-permitted benefits

Permitted 'other' benefits include participation in profits, surrender values, annuity options, increasable options, waiver of premium and disability options

Premiums must be payable annually or more frequently for at least 10 years (unless death or disability occurs earlier)

The total premiums...

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...assed as a transfer of value for IHT purposes. The annual allowance of £3,000 per annum, and gifts out of normal expenditure from income exemption, will mean that in most cases the premiums will be relieved and/or exempt. Care should be taken to ensure that these allowances and exemptions are not being used for other IHT planning purposes and are fully available to offset premiums paid.

What is the highest additional rate of tax a policyholder may face on a chargeable gain?

Answer : Purchase course for answer

The qualifying rules for endowment assurances are as follows:

The policy must pay out a capital sum on survival to the end of the term or death (or on death/earlier disability) and no other benefits

Other benefits may be included, except those of a capital nature before death/disability/maturity 

Premiums must be payable annually or more frequently for at least 10 years (unless death or disability occurs earlier)

The total premiums in any 12-month period must not be more than double the premiums paid in any other 12-month period or exceed more than 1/8th of the total premiums payable over the whole term (or the first ten years where premiums are paid throughout life)

The sum assured on death must be at least 75% of the total premiums paid if the policy ran to maturity. The 75% is reduced by 2% for each year the life assured exceeded 55 at outset

For joint life c...

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...duces a positive figure the tax on the gain will depend on the status of the policyholder. If already a higher or additional rate taxpayer a tax liability of the difference between the higher rate (40%) or additional rate (45%) and the basic rate of savings tax (20%) is charged on the gain

c) If the gain takes the policyholder into the higher rate only the amount of the gain sitting above the higher tax or additional rate threshold is chargeable. There is a mechanism called 'top-slicing' which spreads the gain over the term of the policy to ensure the tax charged is fair and representative of the term the policy has run

If a policy is or becomes non-qualifying, events such as death, surrender or assignment (which is not in the way of gift) will trigger a chargeable event

What is the qualifying rule in respect of the sum assured?

Answer : Purchase course for answer

For UK based life offices, the tax rules are complex, but the effect is that tax is paid at 20% on rental income, interest and offshore income. Expenses can be set against income before tax is calculated. No corporation tax is due on UK dividends and capital gains are taxed at 20% after indexation allowance.

This means that there is no further liability for non-starting rate or basic-rate taxpayers when a chargeable ga...

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...nce of the 0% tax band and basic rate taxpayers’ pay 20%

Higher rate taxpayers need to pay tax at 40% on the full gain. As mentioned above, 'top slicing’ may help to reduce the tax liability

Additional rate taxpayers need to pay tax at 45% on the full gain

What rate of tax is deemed to have been paid in respect of chargeable gains from UK based life offices?

Answer : Purchase course for answer

Due to their specific tax status there are amended qualifying rules for friendly society tax exempt plans which are:

They are subject to a maximum annual premium of £270 or £25 per month

The premium counts towards the annual £3,600 allowance

As w...

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...total premiums payable up to maturity or age 75 where there is no term and the same rules apply where the life assured was 55 or over at outset

What qualifying rules apply to friendly society plans in respect of premium frequency?

Answer : Purchase course for answer

Pension policies are not within the chargeable gains regime, but w...

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... current 2023/24 allowance, except where higher protections apply.

Any changes made to the basic terms and conditions or alterations made during the term can affect the qualifying status of a plan and potentially incur immediate or future tax liabilities. Care should always be taken when advising on existing policies.

Premium loadings

Where a life office has placed a medical loading on a policy that has been fully underwritten with medical evidence being provided, the additional premium payable is not subject to the 75% rule. This is also the case for any loading added for frequency of payments.

Backdating

A policy can be backdated for up to three months and the start date can also be backdated; however, where the backdating goes back further than this the start date will be the date the policy was formally completed.

This could result in the 'first year's premiums exceeding the total premium in any year' rule making a qualifying plan non-qualifying.

Lapsed Policies

Where a policy has lapsed through non-payment of premiums, the plan can be reinstated within the first 13 months without affecting the qualifying status. Where the lapsed period has been more tha...

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...olicy to become a RRQP if any policy beneficiary is in breach of the annual £3,600 premium limit:

As part of a divorce settlement/dissolution of a civil partnership

As a result of a court order

Between husband and wife or civil partners

Into or out of a trust

To enable policy providers to determine whether a policy, which otherwise meets the qualifying criteria, has become non-qualifying or a RRQP, all beneficiaries must give a written statement to the provider within three months of the occurrence of:

A policy issued on or after 6 April 2013

A policy is varied to increase or reduce the premium-paying period or the premiums are increased or reduced (whether the policy was issued before or after 21 March 2012)

A policy assigned after 6 April 2013, except in the case of the allowable assignments (see previous section)

The inheritance of a policy following the death of a beneficiary

Where notice is not received with three months, the policy will become non-qualifying.

How do additional premiums due to medical loadings affect the 75% rule?

Answer : Purchase course for answer

The rules that are in place for the treatment of changes to existing qualifying polices are complex, especially regarding whether the qualifying status of the plan alters after any changes have been made. HMRC have published detailed guidance on their website in the Insurance Policyholder Taxation Manual which can be found on their website at www.hmrc.gov.uk.

HMRC regard a change in terms as:

A substitution - where fundamental changes effectively bring the existing policy to an end and replace it with a new one; or

A variation to the plan that could be significant or insignificant (only significant variations will potentially effect the qualifying status of a plan); or

Arising following the exercise of a policy option by the policyholder

Substitutions

Where changes to the policy are so fundamental that this requires a full reconstruction HMRC regards this as a surrender of the existing polic...

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...holder to make changes to the terms and conditions of a plan, which, if exercised, the insurer is bound to accept. The nature of the option will determine how the resultant changes are viewed by HMRC:

The exercise of a conversion option would be considered a substitution and the resulting new policy would be tested against qualifying rules as described above

A part surrender of a whole of life plan - especially within the first 10 years - would be a substantial variation and the amended policy would also be tested against the qualifying rules

A one-off change in the payment of premiums e.g. from annual to monthly, would be considered an insignificant variation and would not result in any change to the qualifying status of the policy

David has recently changed his endowment to a whole of life plan using the conversion option. How might this effect the qualifying status?

Answer : Purchase course for answer

Some life policies can be subject to tax when a specific event occurs. These ‘chargeable events’ are subject to income tax when they result in a ‘chargeable gain’. NOTE - do not get this mixed up with capital gains tax - this ‘chargeable gain’ is subject to income tax.

When can a chargeable event occur?

This depends on whether the policy is ‘qualifying’ or ‘non-qualifying’ and whe...

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...ved, then the policy will become non-qualifying and a chargeable event will occur on:

Full and part surrenders

Assignments for money or money’s worth – this does not include those made as a result of a Court order on divorce

Policy loans at a non-commercial rate of interest

In what circumstances can a qualifying policy be made non-qualifying and result in a chargeable event on death?

Answer : Purchase course for answer

Chargeable events can give rise to a tax liability, but only where the chargeable event creates a chargeable gain. Gains are calculated as follows:

Event

Calculation

Death

(Surrender value immediately before death + any relevant capital payments) LESS (Premiums paid + total gains on any previous chargeable events)

Maturity or full surrender

(Maturity or surrender proceeds + any relevant capital payments) LESS (Total premiums paid + any previous chargeable events)

Assignment

(Sale proceeds + any relevant capital payments) LESS (Total premiums paid + any previous chargeable events)

Relevant capital payments are any capital sums paid out by the policy prior to the chargeable event (e.g. regular withdrawals). Chargeable events also occur on part surrenders; however, the rules are complicated and beyond the scope of this course.

Example

Tim has surrendered an onshore non-qualifying, whole of life plan and received a payment of £50,000. There have been no other capital payments from the plan or previous chargeable events. The total premiums paid are £27,500.

Chargeable Gain is £50,000 - £27,500 = £22,500.

Chargeable gains are subject to income tax and it is the responsibility of the policyholder to ensure that any liability is accounted for. All payments from UK policies are assumed to have had basic rate tax paid at source therefore an additional tax charge will only occur where:

The individual is already a higher or additional rate taxpayer. They will pay a tax charge of the difference between the higher or additional rate (depending on which is applicable) and the basic rate of tax

The charge...

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...p>In situations where a gain, when added to income, would take an individual’s taxable income over £100,000 (2023/24), care needs to be taken as this would then have the effect of reducing their personal allowance by £1 for every £2 of excess. No personal allowance is available where income in the 2023/24 tax year exceeds £125,140.

The Scottish and Welsh Governments can now set different rates of tax to the rest of the UK. As bonds are treated as savings income, this will influence the interaction between earned and savings/dividend income, particularly when establishing the availability of any ‘top-slicing’ relief.

Adjustment for restricted relief qualifying policies (RRQPs)

These policies are taxed on a part qualifying and part non-qualifying basis. Up to the date it becomes a RRQP it is taxed on a qualifying basis and, from that date, the qualifying basis only applies to the balance of the annual premium limit now used up by other qualifying policies.

Tax is calculated in the normal way for a non-qualifying policy with relief then applied from the formula of:

(Gain x ­total allowable premiums) / total premiums payable under the policy

For example, a gain has been made of £15,000. The total premiums are £105,000 and the allowable premiums are £80,000. The relief on the gain will be:

(£15,000 x £80,000) / £105,000 = £11,428

£11,428 of the gain will be allowable and the remaining £3,572 will be deemed a chargeable gain potentially liable to income tax.

How is the chargeable gain calculated on death?

Answer : Purchase course for answer

Where a gain arises on a policy that is held in a relevant property trust there are several factors to take into consideration when considering who is liable to pay any tax:

Trustees pay the tax where:

At least one of the trustees is UK based

The chargeable event occurs in a tax year after the tax year i...

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...resident

The tax will be added to their other taxable income and tax payable accordingly; however, they are not able to claim top-slicing relief

A chargeable gain arises on a policy held in trust in the tax year that the settlor dies. Who is liable to pay the tax?

Answer : Purchase course for answer

One of the most important tools for inheritance ...

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...e areas, as discussed in the following sections.

One of the main issues facing the personal legal representatives, executors and beneficiaries of an estate is making sure that HMRC have been satisfied. Estates valued in excess of the available nil rate band (£325.000 2022/23) are liable for IHT, at 40% - 36% where at least 10% of a net estate is donated to charity - and any IHT due on an estate must be paid before the estate can be released to the beneficiaries. This can often cause problems as the assets to pay the tax may be tied up in the estate itself.

In summary, the personal legal representatives of a deceased person’s estate would have to complete the following:

Provide an account of the deceased’s estate to HMRC

Pay any tax due in full within six months from the end of the month in which the person died, i.e. if they died in January 2024, the tax would be due to be paid by 31 July 2024

It may be possible to pay tax in instalments but only if the assets in the estate meet HMRC criteria. The first instalment payment of 10% of the total tax due should also be paid six months after the end of the month in which the person died

The personal legal representatives of the deceased cannot obtain a grant until the tax account has been settled. As they have ...

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...t will be in force at that time. Methods for selecting a sum assured can include:

Calculating the IHT liability in today’s terms using current values and rates of tax assuming the tax was payable immediately

Selecting a policy that includes an option to change the sum assured (within limits) at a future date on guaranteed terms without further medical should the IHT liability significantly increase

Consider including indexation so that the sum assured increases automatically. This can be linked to RPI, NAE or a fixed amount. This would ensure that the purchasing power of the sum assured is maintained

Premiums paid to fund an IHT plan on this basis are considered gifts but would normally be exempt under the £3,000 annual or normal expenditure from income exemptions.

In summary, a whole of life policy written in trust would provide a cash payment outside of the deceased’s estate which would be available immediately. The liquid funds could then be used to pay any inheritance tax due, allowing a grant to be obtained and the estate released much more quickly, avoiding any forced sale of assets.

What is the deadline for paying IHT if a person died in September 2023?

Answer : Purchase course for answer

Each individual has several annual exemptions and allowances which are lost if not used. Whole of life plans and endowments written in trust can be used to receive regular payments, effectively reducing the value of the estate over time.

Endowment plans would pay out the value of the units at maturity or the guaranteed death benefit or value of units on death and the benefits would be paid outside of the estate to the beneficiaries via the trustees. As there is an element of life cover, the donor(s) should be in reasonable he...

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...ve cash deposits of £100,000.

The maximum regular contribution they could make within the annual exemptions available would be:

Neil surplus income 

£10,000

Helen surplus income 

£ 2,000

2 x annual exemptions from cash

£ 6,000

Total

£18,000

Over 10 years this would remove £180,000 from the estate, a potential IHT saving of £72,000. (£180,000 x40%)

What is the current annual exemption for IHT?

Answer : Purchase course for answer

An effective way of mitigating an IHT liability is by giving assets away during lifetime to reduce the value of the estate on death that would be liable to tax.

Gifts of cash or other tangible assets to another person are usually classed as Potentially Exemption Transfers (PET’s) and do not create an immediate liability to inheritance tax.  However, if the donor does not survive seven complete years from the date of the gift, the original value of the gift would be tested retrospectively against the donor’s cumulative seven year total and the Nil Rate Band in force at date of death.

Any excess over the nil rate band is chargeable to IHT at death rates. The amount of tax due can be reduced by applying taper relief, depending how long before death the gift was made. Liability for the payment of the tax falls on the recipient of the gift.

A gift inter vivos plan is specifically designed to ...

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...he IHT on the estate would be:

£750,000 @ 40% = £300,000

If James died after 7 years without making any further lifetime gifts the IHT on the estate would be:

(£750,000 – £325,000 NRB) @ 40% = £170,000

The estate would have the additional liability for the entire 7 years after the PET as it is the original value of the PET that is set against the NRB at date of death.

Taking the example above, James could take out a seven year level term policy written in trust for the benefit of Amy to ensure that she had access to liquid funds to pay the additional tax. A level term plan is appropriate as the liability will remain level throughout the term apart from any changes to the amount of the NRB.

What relief can be used to reduce the amount of tax payable on a PET where the donor dies within seven years of making the gift?

Answer : Purchase course for answer

When someone dies without a will, they are said to be intestate and their estate will be distributed according to the laws of intestacy, which vary depending on which part of the UK they lived in when they died and what, if any, family members they have.

England and Wales

Where the deceased leaves a spouse or civil partner but no children or remoter descendants - the spouse or civil partner inherits everything.

Where the deceased leaves a spouse or civil partner and children or remoter descendants:

The spouse or civil partner inherits all jointly owned property, personal chattels and the first £270,000 of the balance of the estate absolutely plus half of any amount above £270,000 absolutely

Children inherit the remaining half of the excess over £270,000 absolutely, held in trust until they reach age 18

For many in this situation, this means that the distribution may not be according...

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...RB on Fred’s death is therefore 100%

On Sarah’s death the NRB is £325,000

The proportion of Fred’s unused NRB is applied to the NRB applicable in the tax year of Sarah’s death

The NRB available to Sarah therefore is her own NRB plus the unused proportion of Fred’s NRB which is £650,000 (£325,000 + (£325,000 @ 100%) = £650,000)

In addition to the standard nil-rate band, a dedicated main residence nil-rate band was introduced in April 2017. The amount is £175,000 in 2023/24 and can be used when a main residence is passed to direct descendants on death, thus reducing the cost of IHT on a family home. Where estates are valued at more than £2 million (after deducting liabilities but before reliefs and exemptions) the residence nil-rate band will be withdrawn at a rate of £1 for every £2 over the £2 million threshold.

This revision test (opens in a ne...

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...test will be added to your CPD certificate.