Tax on chargeable event gain certificate and investment bond
Written by Ray Coman
Life assurance secures anamount payable to the policyholder’s beneficiary on death. The usual intention of life insurance is to secure a fixed amount to loved ones in the event of a death. It is especially valuable where a death may be untimely and the deceased did not have time to accumulate the expected nest egg for the family. Life insurance products benefit from preferential tax treatment. However, a variant product allows the policyholder to hold life funds in riskier investments. The value of the fund varies with the performance of the markets and the value of the benefits are no longer assured. Consequently, the products do not bring the same tax advantages. There are two forms, qualifying products must guarantee a minimum return and have some tax benefit. Non-qualifying funds do not offer that guarantee and any gains are subject to income tax. The gain on a non-qulifying product, often called an investment bond, is reported on a chargeable event gain certificate and is subject to income tax.
A profit on life insurance refers to the excess of the proceeds over total premiums paid. Any profit on maturity or encashment of a qualifying life assurance policy is usually tax free.
The qualifiers for a life insurance policy are complex. However, in broad summary, premiums have been paid for a at least ten years or until death if sooner. Premiums have to be paid in regular amounts and the capital pay-out should be at least 75% of the premiums payable. A policy is cashed in early will be subject to the rules for non-qualifying life assurance.
The life insurance company will ensure the fund qualifies if it is offered as such. Since 6 April 2013, premiums into an ‘investment type’ plan have been limited by tax regulation to £3,600 a year. Therefore, this type of plan now has limited marketability.
Non-qualifying life assurance policies include single premium bonds, guaranteed income bonds, investment bonds or property bonds. The overall gain on the policy on a chargeable event (e.g. encashment, sale or death) is taxed as savings income and comes with a 20% tax credit.
Withdrawals from the policy are known as ‘partial encashments’. Up to 5% of the premium per year (on a cumulative basis) can be withdrawn with no immediate tax liability. Where withdrawals exceed the 5% limit, the excess is:
- Divided by the number of years since the policy was taken out;
- Taxed as top slice of income;
- The tax is multiplied by the number of years since the policy was taken out;
- And a notional 20% is deducted from the overall liability.
When the policy is finally encashed, the profit (i.e. proceeds on encashment, less initial premium and add tax free withdrawals) is taxed in the same way as excess withdrawals. Instructions are in ITTOIA 2005 536. The policy provider has to issue a “Chargeable event gain certificates” with the encashment and national tax already calculated.
Taxpayers should plan to delay encashment until they expect to be basic rate taxpayers. It can be effective tax planning where tax rate is expected to be lower in retirement.
The 2020 Budget introduced a new regulation that allowed personal allowance to be included in the calculation of top slicing relief. In effect this is a better deal for the taxpayer.