Tax relief on life assurance policies
Written by Ray Coman
An assurance product provides a fixed benefit defined in advance. An insurance product covers for a loss. A life policy is a form of assurance. It pays out on the death or terminal illness of the policyholder. The beneficiaries are family members and loved ones, although charities and associations can also be nominated. There is no tax relief for employees and individuals when premims are paid, and there is usually no tax liability when the policy is cashed in. A different type of life insurance policy contains investment, it is often cashed in during a person's life and any gain would in that case be taxable. Tax relief on life assurance policies is available for small business owners and directors of contractor companies. Life insurance premiums are tax deductible as a business expense. By contrast with income protection, the proceeds or pay out is not taxable.
Types of life assurance policy
Types of life assurance policy
A whole of life policy pays a cash lump sum whenever the life assured person dies. By contrast, a term policy will only pay out for a fixed duration set at the outset of the policy. With a decreasing term assurance, insurance proceeds are designed to match the outstanding mortgage. The premiums therefore reduce with the repayment of mortgage principal.
Individual policies
Death-in-service arrangements are a common feature of a benefits package. However, those without workplace schemes, including the self-employed and retired, can chose a life product via an independent broker. Since the premiums are treated as being paid out of net pay, they are not tax deductible. No tax relief is available on payment of the premiums. A policy invariable ends on termination of an employment and some providers offer to continue the policy via private arrangement for those who do not carry on in employment.
Benefits are usually paid once a person dies but can include terminal illness. In most cases there is no income tax or capital gains on receipt of proceeds.
Investment bonds
However, income tax is payable when the life insurance contains an investment element. These are usually marketed as investment bonds. It is usually clear if a product is non-qualifying because these products are marketed accordingly. Rather than paying in monthly premiums, the bond is usually started with one lump sum investment. It is a whole of life policy, and proceeds are payable on death. However, it is also possible to cash the initial investment, and often the whole fund is redeemed during the policyholder’s lifetime. The products include a speculation that a profit will be returned from investments made by the insurer. These are the only policies subject to income tax and are explained in a separate report.
Tax position of beneficiaries
The life cover is usually written into Trust so that the beneficiaries are not treated as receiving income. As a result, proceeds paid to beneficiaries are neither income nor capital gains for tax purposes. Where, the lump sum is used to purchase a pension, the resulting annuity would be treated as income of the beneficiary.
Where the usual route, of paying benefits into a Trust, is followed, proceeds and are not part of the estate for inheritance tax purposes. There is often no inheritance tax to pay, however this is expended upon in the section below.
Workplace schemes
Offered as part of the renumeration deal, life assurance is a benefit that pays out to the named beneficiaries of an employee who dies or become terminally ill. It is not necessary that the death occurred while at work, only that it is during the term of the work contract.
Life assurance provided to employees and directors is a non-taxable benefit. The premiums can be deducted from business profits. A condition is that the benefit should be reasonable in relation to the overall remuneration package.
By contrast with income protection, the pay-out is not taxable.
Since compensation is paid out to a trust for the family of the deceased, the employer is not liable on any proceeds.
Group policies
Typically provided for employers with more than 10 staff, life assurance is usually a core part of the insurance benefits package. The benefits count towards the lifetime allowance for pension purposes.
Relevant life
Introduced on ‘A’ day, 6 April 2006, relevant life allowed companies the flexibility to provide death-in-service benefits to specific employees.
The plans are suitable for smaller companies including those with just one director/shareholder. This is sometimes marketed as Contractor Life Insurance.
Since the benefit is not included in the calculation of lifetime allowance, it is suitable for higher earning employees. It avoids a charge caused by the combined life assurance benefit and pension value exceeding the lifetime allowance.
Unincorporated businesses cannot benefit from tax relief from life insurance. This is because the there is an element of self-interest and therefore it cannot be regarded as exclusively for work purposes. The Anderson principle is expanded upon in the report on income protection policies.
