5: Taxation of Life Assurance and Pension-Based Protection Pt. 1 Flashcards
(18 cards)
What is the normal tax treatment of death benefits under an employer’s group life assurance policy?
The death benefit is not liable to any form of taxation when paid to the beneficiaries.
When might IHT apply on death benefits paid under an employer’s group life assurance policy?
When it’s paid to the estate and not the beneficiaries.
Non-domiciled individuals are only subject to IHT on assets where?
UK
What is the difference between UK domicile and residence for Inheritance Tax purposes?
Domicile affects whether worldwide assets are taxed (deemed domicile = worldwide IHT liability).
Residence alone means only UK assets are liable to IHT.
How long must the donor survive after gifting to a friend for the gift to be exempt from IHT?
7 years (full exemption after 7 years).
What happens if the donor dies between 3 and 7 years after gifting?
IHT is charged on a tapered basis (reducing tax over time).
Does the relationship (friend vs family) affect the IHT exemption period for lifetime gifts?
No, the 7-year rule applies regardless of who the gift is to.
Ralph’s total annual income is £165,000. His early surrender of an onshore life assurance policy, which he has owned for five years, causes a chargeable event. If the total amount of premiums paid is £30,000 and the surrender value is £38,500, what is his personal tax liability?
- Calculate the gain
Surrender value − Total premiums paid
£38,500 − £30,000 = £8,500 gain - Top-slicing relief
Since Ralph held the policy for 5 years, apply top-slicing:
£8,500 ÷ 5 = £1,700 (annual slice) - Determine tax rate
Ralph’s income is £165,000, well above the higher-rate threshold. So the entire gain is taxed at 45%, the additional rate. - Apply tax rate
£8,500 × 25% = £2,125
Why 25%? Because basic rate tax (20%) is deemed paid on the gain, and Ralph pays the difference between his marginal rate (45%) and 20%.
Tina is a higher-rate taxpayer with annual income of £85,000. She surrenders her onshore life assurance policy after 8 years. The total premiums paid were £24,000 and the surrender proceeds were £35,000.
What is her personal tax liability due to the chargeable gain?
- Gain: £35,000 − £24,000 = £11,000
- Slice: £11,000 ÷ 8 = £1,375
- Adding the slice to her income (£85,000 + £1,375 = £86,375) keeps her within the higher-rate band.
- As a higher-rate taxpayer (40%), she pays the difference between 40% and the basic 20%:
£11,000 × 20% = £2,200 tax liability
Priya earns £48,000 a year—just below the higher-rate threshold. She cashes in an onshore life policy after 4 years, receiving £36,000 in proceeds. She paid total premiums of £25,000. What is her personal tax liability due to the chargeable event?
- Gain: £36,000 − £25,000 = £11,000
- Annual slice: £11,000 ÷ 4 = £2,750
- Assessing the slice:
- Income + slice: £48,000 + £2,750 = £50,750
- This crosses into higher-rate territory (threshold is £50,270), so part of the slice is in higher-rate
- Top-slicing relief: Instead of taxing the full £11,000 gain at the higher rate, we only treat £480 of each slice (i.e. £2,750 − £2,270) as higher-rate and the rest at basic.
- Effective tax:
- Basic rate (20%) on majority of gain
- Higher rate (40%) on portion pushed over threshold
- Tax on the gain: Approx £2,090 (depending on exact personal allowance or other income sources)
Which type of life assurance pays out on the second death of two insured lives?
Joint life last survivor/second death policy
Why is a joint life first death policy unsuitable for covering IHT on a couple’s estate?
It pays out too early, on the first death, whereas IHT is due on the second death. Tax arises only after both have passed, so payout timing is key.
When can Capital Gains Tax arise on a life assurance policy?
When the policy is assigned for money or money’s worth.
Example of this is someone selling an asset to another as opposed to gifting it
Does assigning a policy as a gift trigger Capital Gains Tax?
No, gifts do not trigger immediate CGT.
What is the maximum amount you can withdraw tax-deferred from a life assurance bond each year?
Up to 5% of the original investment per policy year, for up to 20 years.
What happens if you withdraw more than the 5% cumulative allowance from a bond?
The excess amount creates a chargeable event and is taxed immediately in that tax year.
How do you calculate the chargeable gain on final surrender of a bond with 5% withdrawals?
Surrender Value - (Original Premium - Total 5% Withdrawals) = Gain
How do you calculate the chargeable gain on final surrender of a bond with 6% withdrawals?
Surrender Value - (Original Premium - Total 5% Allowable Withdrawals) - Excess Withdrawals Already Taxed = Gain
