Foreign life insurance policies
Written by Ray Coman
Life insurance pays out to a beneficiary, usually a dependent loved one, on death. Many policies will be used to invest in the markets and the investment will be returned to the policyholder on a chargeable event. A chargeable event is death, maturity (i.e. the policy reaching the end of its agreed term), a surrender (i.e. a request for the policy to be encashed before the end of its term), a partial encashment (i.e. a surrender of part of the sum before the end of its term), and an assignment for money or money’s worth (which means transferring the benefit of the policy to someone else.) This report precises the tax implication of a chargeable event with specific focus on foreign life insurance policies.
A beneficiary of a life insurance that pays out on someone else’s death will not be liable to tax on the payout. Usually the policyholder will not be liable to inheritance tax either because the policy is written into a Trust. If the benefactor is not UK resident the policy will rarely be a UK situs assets and therefore not liable to UK inheritance tax in any case.
Usually, policies that pay out to a beneficiary -or beneficial owner- other than the policyholder are whole life policies. Provided the premiums are paid, a whole life policy will cover the policyholder for the rest of that person’s life.
For UK policies, premiums to a qualifying policy cannot exceed 3,600 a year and usually have a minimum term of 10 years. It is rare that a foreign life insurance is qualifying but the issuer will confirm if this is the case.
If a life insurance policy is paid to another beneficiary and it is not qualifying, the payout to the policyholder will be potentially subject to tax.
Non-qualifying life insurance products that pay out to the policyholder can allow for partial surrender or encashment during the life of the policyholder. An encashment can occur if for instance the policyholder no longer considers the beneficiaries need or deserve a financial protection, or because the policyholders need or want the original investment before the end of the agreed term.
If the policy holder dies -during the term of the investment- a surrender of the policy will be treated as occurring the day before death. For tax purposes, death is similar chargeable event to surrender of policy during the policyholders lifetime. The person paying in the premiums is regarded as the beneficial owner. The net proceeds is part of the policyholders estate and potentially liable to inheritance tax.
The policy is invested (in the markets) by the insurance company and sometimes appreciate in value. Any gains- or appreciation in value – are liable to UK tax if the policy is cashed in during the policyholders lifetime. This type of policy -as opposed to one written in someone else’s name- is therefore taxable. For a UK policy any gain is reported on a chargeable events certificate. Although described as a gains, the appreciation in value is subject to income tax rather than capital gains tax and will enjoy the tax benefit of ‘top slicing relief.’ This is explained further in the report on non-qualifying life insurance.
A foreign policy is one in which the issuing company is not UK resident (or not a UK branch of an overseas insurer.) In some cases, foreign tax would be suffered at source on the policy. This will probably not be the case for policies which are held in low tax jurisdictions. The income is reported in the foreign supplement of the Tax Return with gain entered into box 43, and any foreign tax deducted in box 45. If the taxpayer is self-filing a Tax Return online, the gain is reported in the section related to gains from life insurance policies which is part of the section on other overseas income and gains.
The gains is treated as arising in the tax year in which the chargeable event occurs. The UK tax year ends on 5 April and the earliest a Tax return can be filed is 6 April following the end of the tax year.
The issuing company will confirm the amount of “gains” usually on documentation accompanying the payout. It is the gain element only and not the whole payout which is subject to tax. Foreign life insurance gains cannot be reduced by any capital losses. This is because even though described as gain, the profit element is taxed as income. The amount of profit taxed as income is appreciation in value.
If the policy has not made a gain, no entry is required on the Tax return and no UK tax liability arises.
A policy can be transferred to a spouse or civil partner without giving rise to a chargeable event.
It is possible to make withdrawals of initial capital up to 5% per annum without a taxable event occurring. In some cases, the gain element of the policy is only realised at the end of its term (referred to as maturity), on death of the policyholder, surrender (before ethe end of the term) or partial encashment before the end of the term where the encashment is greater than 5%.
Policies with no surrender value (or surrender value of no more than premiums paid) that pay out on death only, do not give rise to tax.
It is very rare that a foreign life policy will be qualifying and the conditions which give rise to qualifying foreign life policies are beyond the scope of this report. Unless, the issuing company has made a notification of a special UK tax exemption, the foreign policy should be regarded as taxable.
Holders of foreign life insurance often take the policies out when not UK resident. In that case, the policyholder would be entitled to a reduction in taxable element based on the number of days that he or she was not UK resident as a portion of the number of days that the policy had been held.
The amount of gain (as reported in box 43 of the foreign pages of the Tax Return) is therefore only the portion which relates to UK residency.
For gains before 6 April 2013, if the policyholder was different to the beneficiary, the gain is calculated by reference to the policyholder. In many case the policyholder (person paying in premiums) is the same as the beneficiary (person receiving payouts on encashment or maturity), and therefore the change in rules on 6 April 2013 can be ignored.
Most non-residents arriving in the UK, will be able to claim the split year treatment. The split year treatment will treat an individual as taxpayer as UK resident from the date of arrival (as opposed to from the start of the tax year of arrival.) For individuals claiming the split year treatment, foreign days is counted up to the day before the date of arrival.
A spike in income can cause a taxpayer to suffer greater tax than had the same amount of income been spread over more than one tax year. Top slicing relief aims to put the taxpayer in a position no worse than if the gain had been paid evenly over its term. The relief will reduce tax for taxpayers who would be taxed at higher rate but for the gain, or would be taxed at additional rate but for the gain.
The calculation is complex but it is carried out by tax software (such as the HMRC tool.) Policy term express in number of years appears on box 44 of the Tax Return. This entry is used to calculate top slicing relief. The number of complete years that the taxpayer was not UK resident will be included in box 44. Therefore, top slicing relief only applies to the period in which the beneficiary was UK resident.
If there has been more than one gain, in the tax year, it must be reported on the additional pages of the Tax Return.
The number of years is rounded down (so effectively box 44 represents the number of complete years.) As an exception, the number used in eth top slicing calculation (as appears in box 44) cannot be less than 1.
Provided a chargeable gain does not result in additional tax due, and the gains shown on the certificate is less than £10,000 there is no need to report such a gains to HMRC. Top slicing relief calculation can get complex and it is advisable to run the gain through a tax software (such as the online Tax Return) before concluding no extra tax arises.
Overseas assets, income or gains letters are sent from HMRC due to information exchange with other countries. Gains on foreign life insurance policies are a common reason for the HMRC nudge letter. Overseas bank account, rental profits and income from investments are common reasons. Gains on foreign life insurance are not straightforward to calculate, but the insurer will usually provide notification of the amount of gain via a chargeable events certificate (or similar) that accompanies the payout.