A change to the taxation of life insurance policies was introduced from 11 March 2020 which provides an important planning point for trustees with such assets.
Insurance policies can be qualifying or non-qualifying. If a qualifying policy matures, there is no tax to pay unless the policy is cancelled within ten years of commencement. Non-qualifying policies, commonly called “single premium insurance bonds”, get taxed on maturity or surrender under the rules of life insurance gains.
Full surrenders of non-qualifying policies are “chargeable events” for tax purposes, but partial surrenders are tax-free if they do not exceed 5% of the initial investment per policy year.
Gains are chargeable to income tax, rather than capital gains tax, being treated as savings income and the “top-slice” of an individual’s income. These gains carry a 20% notional tax credit meaning basic-rate tax payers have no further liability; however, higher-rate or additional-rate taxpayers will have further tax to pay.
The additional tax liability resulting from the life insurance gain is reduced by “top slicing relief” (TSR). TSR is available to individuals on both onshore and offshore bonds. TSR reduces the rate of tax by “top slicing” the gain to reflect the number of years during which the gain has been earned and then adding this “top slice” to an individual’s other income to calculate the additional tax on the “slice”. This is a complex calculation.
The calculation of TSR has changed from 11 March 2020. If the life insurance gains push an individual’s “adjusted net income” over the personal allowance income limit of £100,000 (after which the allowance is reduced by £1 for every £2 over the limit), the full personal allowance is reinstated when calculating TSR. “Adjusted net income” is the individual’s net income reduced by the gross amount of any gift aid payments or personal pension contributions.
TSR is not available to trustees. Trusts pay income tax at a fixed rate of 45% subject to the first £1,000 which is subject to the 20% rate. Therefore, if trustees are minded to cash in a policy in future, subject to any inheritance tax implications, they should consider appointing the policy to the beneficiary to cash in personally, thereby allowing them to benefit from TSR. The appointment would not be a chargeable event for income tax purposes and having the beneficiary trigger the gain should mean less income tax to pay as a result.