LEARN THIS! Chapter 5 - (6 exam questions) Taxation Of Life Assurance And Pension Based Policies

Question 1

What part of a life policy can be subject to income tax or CGT?

Answer 1

Any investment gain

The payment of someone’s sum assured is not taxed but any investment value that has built up within a policy could be taxed

investment gains on life policies can be subject to income tax.

If the policy has been sold on the second-hand market a CGT liability may also arise.

Question 2

For context

Answer 2

If the policy is purely protection-based, and no investment gain is likely, then there should be no income tax or CGT implications.

If it is investment-based, such as an endowment or investment bond then, potentially, there could be a tax liability for the policyholder, or their estate.

Question 3

What rules do insurance policies must meet to be deemed as ‘qualifying’

Answer 3

Question 4

Qualifying / non qualifying rules in practise

Answer 4

Question 5

Qualifying / non qualifying rules in practise

Answer 5

Question 6

Qualifying / non qualifying rules in practise

Answer 6

Question 7

The basic qualifying rules change depending on the type of insurance policy

The following includes the policies individually and highlight some of their features, plus the key differences with regard to their qualifying rules.

Only an awareness of the rules covered next is required for your R05 exam. So, don’t worry too much if not much sticks…!

Answer 7

Question 8

There are certain ‘specified events’ that can occur that causes a qualifying plan to become a non qualifying plan, and therefore, lose its tax-exempt status unless some other certain conditions are met

Be aware of these rules You dont have to know them in full detail for RO5

Answer 8

Extra premiums and policy debts
Any extra premiums charged due to higher risks are disregarded when considering the qualifying rules

Backdating the start date of a policy
If a policy is backdated by 3 months or less it will be treated as if it started on the earlier date. If the backdating is for a longer period, its commencement will deem to have been on the date of policy completion. This could affect premium-based qualifying rules such as the 1/8th rule, invalidating a policy’s qualifying status.

Reinstating a lapsed policy
Policies can lapse for a variety of reasons such as affordability or poor organisation. This means premiums are not paid. A policy can be reinstated and, if this occurs within 13 months of the first unpaid premium, the qualifying status of the plan will be unaffected, as long as the plan conditions and premiums are unchanged.

If the policy conditions change and/or a different premium is charged, the policy will be treated as a new one, and this can affect its qualifying status. If reinstatement does not occur within 13 months, this will have the same effect.

Substitutions and variations
The rules around substitutions are complex and varied and outside the scope of this study guide. For both substitutions and variations, when considering whether a policy can retail its qualifying status, HMRC would need to determine whether the variation is ‘significant’ or not. Also, the benefits provided by the policy would have to be approximately the same.

Changes of life assured
A change of life assured is viewed as a fundamental change by HMRC. The policy would be viewed as new and could be classed as either qualifying or non-qualifying.

Question 9

Non-qualifying policies

These are policies that either fail the qualifying rules from outset, or become non-qualifying as a result of the rules being broken.

Give an example of a policy that is non qualifying from the outset

Answer 9

The most common type of non-qualifying policy is one where premiums are not regularly paid,

An example of this is an investment bond which is non qualifying because it is a one-off premium.

Question 10

Summary

Answer 10

Question 11

Answer 11

Question 12

At a high level, what difference occurs in relation to taxation when a life assurance policy is onshore and when it is offshore

Answer 12

The taxes paid on the life fund internally by the insurer will differ

The calculation of any policyholder liabilities on any gains will differ

Question 13

There are 2 differences that occur in relation to taxation when a life assurance policy is onshore and when it is offshore

These are that:

The taxes paid internally on the life fund by the insurer will differ

The calculation of any policyholder liabilities on any gains will differ

Tell me specifically about how the internal taxes that the insurer pays differs when an life policy is onshore compared to offshore

Answer 13

Question 14

There are 2 differences that occur in relation to taxation when a life assurance policy is onshore and when it is offshore

These are that:

The taxes paid internally on the life fund by the insurer will differ

The calculation of any policyholder liabilities on any gains will differ

Tell me specifically how the calculation of the policyholders liabilities on any gains made changes if a fund is onshore compared to offshore

Answer 14

Question 15

For context:

Answer 15

When comparing onshore and offshore funds is not a question of paying more tax for onshore policies than for offshore but considering who pays the tax: the insurer and/or the policyholder.

Because an onshore policy fund is taxed internally this may mean less or no direct personal liability for the policyholder. Little or no tax may be levied on an offshore based policy, which may result in higher potential investment growth (if an investment-based policy) but it may also mean a higher investor tax liability, as there is no insurer-paid tax that can be used to reduce the individual’s tax bill.

Question 16

For tax to be due on a life assurance-based policy investment gain, WHAT must have occurred.

Answer 16

a chargeable event

Question 17

For tax to be due on a life assurance-based policy’s investment gain, ‘a chargeable event’ must have occurred.

What are these different events and how do they differ for qualifying and non qualifying policies

Answer 17

For non qualifying policies remember: DAMPS

DEATH
ASSIGNMENT for money or money’s worth
MATURITY
PART SURRENDER
SURRENDER

For qualifying policies:

it is the same except with one extra event which is where the policy has a loan taken out against it as security. Also, Death and Maturity are only ‘chargeable events’ for qualifying policies if the policy is ‘made paid-up’ within 10 years or 3/4 of the term whichever is earlier.

NOTE: On death, the calculation of any chargeable gain is based on the SURRENDER VALUE of the policy immediately before death, not the death benefit

make sure you know the definition of ‘made paid up’

Question 18

Answer 18

Question 19

Answer 19

Question 20

If a life assurance policy is held in trust how is it taxed?

Answer 20

All the same rules apply to life assurance polices in trust like they do with normal life assurance policies. Ie qualifying/non qualifying and that life assurance benefits themselves are not taxable, but the investment gains made on a policy potentially are.

Because it is held in trust however, it has the following difference:

If the settlor still alive any gains will be assed against them

If the settlor has died and one trustee is UK resident, then the gain will be assessed on the trustees.

Question 21

If a life assurance policy has been sold on the second-hand market, how is it taxed?

The image is an example of a policy being sold

Answer 21

If a policy is sold, and it is sold for money worth, CGT could be payable by the purchaser if a gain is made on any future disposal of the policy

the way it is taxed depends on whether it is a qualifying policy or a non qualifying policy

Question 22

Remember

Answer 22

Question 24

SUMMARY

Answer 24

Question 25

Any ONSHORE life fund of a UK-based insurer is subject to taxation and is paid at the following rates: SEE IMAGE None of these taxes can be reclaimed by any taxpayer. Bearing this in mind ( ie how onshore bonds are taxed) why are onshore life funds not the best for investors who are non-taxpayers?

Answer 25

Nature of Onshore Bonds: Onshore bonds are investment products issued by UK-based insurance companies. These bonds allow investors to invest in various funds with the insurance company managing the underlying investments. Taxation of Onshore Bonds: The insurance company pays tax on the investment income and gains generated within the bond at the basic rate of income tax (currently 20% in the UK). This tax is paid by the insurer directly and is considered when calculating the returns credited to the bond (ie they policyholder will get less) Implication for Policyholders: Basic Rate Taxpayer: For basic rate taxpayers, the tax paid by the insurer is treated as satisfying their tax liability on any gains. This means they owe no further tax on these gains unless they become higher or additional rate taxpayers. Higher/Additional Rate Taxpayer: These taxpayers may have to pay additional tax if their marginal rate of tax exceeds the basic rate. They would owe the difference between the higher or additional rate and the basic rate already paid by the insurer. Non-taxpayer: Non-taxpayers (individuals whose income is below the personal allowance and therefore don't pay any tax) cannot reclaim the tax paid by the insurer. Even though no further tax is due from them, they can't benefit from a refund of the 20% tax already paid within the bond. SO basically, onshore bonds are bad for non taxpayers and good for basic and higher/additional taxpayers

Question 26

How are offshore life funds taxed internally

Answer 26

Offshore funds are where the insurer is based offshore, such as in the Isle of Man, Guernsey or Jersey, and not in the UK. Most offshore funds are non-qualifying The funds pays little or no tax on their funds internally. The only tax likely to be levied is a small amount of non-reclaimable withholding tax.

Question 27

What is CGT? When are life assurance based policies subject to CGT? What is the CGT threshold?

Answer 27

CGT is a tax paid by UK residents on gains made ANYWHERE IN THE WORLD The only time CGT is payable on a life assurance based policy is when an individual who is not the original owner realises the gain Each individual is entitled to £6,000 of gains free from CGT for the current tax year but any gains above this exemption will be taxed at 10% and/or 20%

Question 28

TRUE OR FALSE In terms of IHT, estates valued at over £2,000,000 lose the RNRB allowance (Currently at £175,000) at a rate of £1 for every £2 over this threshold.

Answer 28

TRUE

Question 29

IHT in context and current IHT rates

Answer 29

Question 30

IHT in context and IHT rates

Answer 30

Question 31

What are the exempt transfers of IHT?

Answer 31

NOTE: If it says it is a 'lifetime exemption' it just means that the donor must be alive when the gift is given

Question 31

IHT due can be reduced by certain reliefs such as agricultural, quick succession and business relief. What is quick succession relief and what is its purpose? Includes an exam question

Answer 31

Quick Succession Relief (QSR) is where an individual inherits an estate subject to IHT, and then dies within five years leaving their estate subject to IHT. The aim of QSR is to try and ensure the same assets are not subject to IHT twice. In the exam question the answer is 'reduces' because there are two estates; One that was passed on from Mavis which is is subject to QSR and therefore no tax and Claires estate which is subject to IHT as normal, so therefore, it reduces the tax burden as oppose to there being no tax

Question 32

3 examples of IHT various exempt transfers in context

Answer 32

Question 33

What are Potentially Exempt Transfers?

Answer 33

These are outright gifts, either to individuals, or into certain types of trust known as absolute trusts. The giver of the PET is known as the donor, and the recipient the donee. If the donor still benefits from the gift, then it is 'a gift with reservation', and will be liable to IHT. The donor cannot benefit from the gift in anyway

Question 34

As long as the donor survives for 7 years, the PET will be not chargeable for IHT. If the donor does not survive for 7 years, IHT will be chargeable, but some relief may be available, called taper relief.. What are the Taper relief rates?

Answer 34

See image for rates NOTE: Taper relief does not reduce the value of a gift, so it does not reduce the estate value on death. (ie, the estate value will remain the same) It only educes the tax payable on the gift. There must be tax due for taper relief to be applied. ie No tax = no taper relief.

Question 35

'Gifts with reservation' in context

Question 36

IHT in context

Answer 36

Question 37

What are Chargeable Lifetime Transfers (CLT) ? What is 'grossing up' in relation to this?

Answer 37

These are usually transfers into most types of trust, such as a discretionary and interest in possession trust. (PET are for absolute trusts) If the value of a CLT is less than the relevant Nil Rate Band (£325,000 for the current tax year) then no lifetime IHT is due. However, if the transfer is more than this amount, lifetime IHT at a 20% rate will be due on any excess Grossing Up: Where the donor transfers a greater amount into the trust after making an initial CLT where lifetime IHT has been paid. On this additional amount they will pay IHT of 25% rather than 20%

Question 38

Key info regarding IHT

Answer 38

Question 39

Valuing transfers for IHT purposes The value of a transfer is the value of the loss to the estate. This is usually its market value as at the date of the gift, but in some cases, it is not that straightforward. Certain assets may be worth more as a pair than individually. If one is given away the loss to the estate will be greater than the value of the item given away.

Answer 39

Question 40

The order to calculate any IHT liability

Answer 40

Question 41

SUMMARY

Answer 41

Question 42

GREAT TO KNOW

Answer 42

Question 43

Tell me about onshore funds and their tax liability See examples for context I have also added the chargeable event types for reference

Answer 43

These are taxed internally This taxation equates to a credit for basic rate income tax in the hand of the assured. (Basic rate is already paid) It is non-reclaimable for non-taxpayers. Higher rate taxpayers have an additional 20% liability (40% - 20% paid) on any gains made. Additional taxpayers have a further 25% liability (45% - 20% paid) on any gains made. To calculate gains, we first deduct any premiums paid. REMEMBER: For an onshore bond, the policyholder must be a higher or additional rate taxpayer for any further income tax to be due and for an income tax charge to be levied: a chargeable event needs to occur, a chargeable gain has to be made, and the policy must be either qualifying but the rules have been broken, or non-qualifying.

Question 44

Tell me about offshore funds and their tax liability See example for context I have also added the chargeable event types for reference

Answer 44

These have little or no tax deducted internally. There MAY be a small deduction made for non-reclaimable withholding tax. Basic rate taxpayers have a liability for 20% income tax (as no tax taken at source like with onshore funds). Higher rate taxpayers have a 40% liability (as no tax taken at source). Additional rate taxpayers have a 45% liability (as no tax taken at source). REMEMBER: for an income tax charge to be levied a chargeable event needs to occur, a chargeable gain has to be made, and the policy must be either qualifying but the rules have been broken, or non-qualifying.

Question 45

Who pays tax for polices in trust?

Answer 45

Question 46

CGT in relation to insurance

Answer 46

In relation to gains on life assurance-based policies, there is only one situation where a gain may occur that is subject to CGT. This is when the policy has been sold on the second-hand market. Here, the current owner of the policy (the assured) is different from the assured at policy inception. Regarding CGT, and an individual’s liability, each individual is entitled to £6,000 of gains free from CGT in the current tax year. Any gains above this allowance will be taxed at 10% and/or 20%.

Question 47

IHT rates

Answer 47

IHT is chargeable at: 0% on assets up to the value of the NRB of £325,000. 0% on PETs such as outright gifts or transfers into a bare trust. 20% on chargeable lifetime transfers such as a payment into a discretionary trust. 25% if paid using grossing up rules. 36% if at least 10% of a net estate has been left to charity. (the ‘net estate’ is the estate of a person who has died, based on the value of all assets minus: all debts of the person who died, funeral costs, expenses of administering the estate, and any other allowable deductions). 40% on the estate on death plus any gifts or transfers in the preceding 7 years.

Question 48

Examples of IHT in context

Answer 48

Question 49

When is IHT payable?

Answer 49

Lifetime IHT (CLT's): Due by 6 months after the end of the month transfer occurred. If the transfer is made between 5th April and 1st October in any tax year, then IHT will be due by the following 30th April. Paid by the recipient of the gift or transfer. Death IHT: Due within 6 months after the end of the month death occurred in. Can be paid in instalments in certain cases, but interest will be charged. Probate will not be granted until any IHT bill is paid. Paid by the estate’s personal representatives.

Question 50

As probate, which is the release of the estate on an individual’s death, will not be granted until any IHT due has been paid this can cause several different issues. What are some potential issues?

Answer 50

Question 51

Summary of different taxation

Answer 51

Question 52

List the various actions that the testator could do that will revoke a will

Answer 52

Question 53

What is a deed of variation?

Answer 53

Individual can also redirect a legacy if they do not wish to accept it for any reason. This is done by completing a deed of variation. This must be drawn up within two years of death of the individual(s) who left the initial legacy. It is a legal document that redirects the legacy to new beneficiaries. The most common situation where a variation will be written is in cases where the will is not particularly tax efficient. NOTE: The deed must contain a set statement that ‘the variation is made to have effect for Capital Gains Tax (CGT), Inheritance Tax (IHT) or Capital Gains Tax (CGT) and Inheritance Tax (IHT) as if the deceased had made it’ and have no consideration for money/money’s worth (the individual has not been paid to redirect the benefits)

Question 54

A beneficiary from a will can reject the inheritance outright. What is this known as?

Answer 54

This is known as a disclaimer.

Question 55

When must a deed of variation be actioned by?

Answer 55

Question 56

What happens to joint assets upon death of one of the owners

Answer 56

Any joint assets, for example a main residence under joint tenancy, joint bank accounts and personal chattels, pass automatically to the survivor.

Question 57

In the laws of intestacy what are children known as?

Answer 57

'issue'

Question 58

in the laws of intacacy what is the figure you must remember if there is a spouse and a child (issue)

Answer 58

322,000 Look at bottom left to see why you must know this figure Where there is 'issue' the spouse will receive the first 322,000 outright and 50% of the remaining amount. The other 50% will be shared amongst any issue

Question 59

The definition of chattels is: WHAT

Answer 59

‘All tangible moveable property except: money or security for money property used at the date of death by the intestate solely or mainly for business purposes property held at the date of death solely as an investment

Question 60

Question

Answer 60

Question 61

True or false

Answer 61

In intestacy cases, no executors have been named and it often falls to the next of kin who will be known as the administrator. Executors and administrators are collectively known as personal representatives. Grant of probate is where there is a valid will and grant of letters of administration where intestacy applies(no valid will)

Question 62

Summary of the various tax's that apply to insurance polcies

Answer 62

Question 63

John gave £400,000 to his daughter and survived for 3 and a half years after the gift was made. What is the tax situation in relation to this gift? It is a potentially exempt transfer. It is a chargeable lifetime transfer. It is a potentially exempt transfer that is now chargeable. It is an exempt transfer that is now chargeable.

Answer 63

It is a potentially exempt transfer that is now chargeable. John, as the donor, has not survived for seven years post gifting so this PET is now chargeable. As he has survived for 3 and a half years post gift taper relief at 20% will be due. Note how, in this question, option A is technically correct, but option C is ‘more-complete’. You may find this type of question in your R05 exam.

Question 64

Simon has a holiday home in Spain. He has gifted this equally to his two daughter Sophie and Marnie. Simon continues to holiday using this home rent free. As a gift with reservation this will be part of… Simon’s estate. Simon, Sophie’s and Marnie’s estate equally. 50% in Simon’s estate, the remainder divided between Sophie and Marnie. Sophie and Marnie’s estate.

Answer 64

Simon’s estate. This holiday home will 100% fall into Simon’s estate. As a gift with reservation it falls wholly into the donor’s (Simon’s) estate.

Question 65

Lisa gifted £100,000 to her son Ollie. She had already used all available exemptions. She died four years later leaving an estate of £825,000. How would this gift be treated for inheritance tax on Lisa’s death? It would receive no taper relief and be taxed at 40%. It would form part of Lisa’s nil rate band and be tax free. 20% taper relief would be due with the remainder taxed at 40%. 40% taper relief would be due with the remainder taxed at 40%

Answer 65

It would form part of Lisa’s nil rate band and be tax free. Any previous transfers in the last seven years are assessed first on death of the donor Lisa. The £100,000 would therefore use up part of Lisa’s nil rate band and would not be taxed. No taper relief would be applied as it uses part of her nil rate band – no tax no taper!

Question 66

James and Jane are not married. They have a son, Ben. James dies intestate with an estate worth £342,000, excluding jointly-owned assets. Who would receive his estate? £20,000 would go to Jane and £322,000 to Ben. Jane would receive the entire £342,000. Ben would receive the entire £342,000. Ben would receive £20,000 and Jane £322,000

Answer 66

Ben would receive the entire £342,000. Jane would receive nothing, as James has died intestate and the couple are not married. If Ben is at least age 18, he will inherit the entire estate. If they were married it would be 322000 to Jane plus 50% of remainder and other 50% to ben, so 10k to ben if they were not married

Question 67

James has assigned a non-qualifying life assurance policy to Nick, as a gift. Ignoring inheritance tax what are the taxation liabilities at assignment? There are no liabilities. Income tax for James. Income tax for Nick. Capital gains tax for James.

Answer 67

There are no liabilities. The assignment by James has been made as a gift, and not for money or monies worth. It is therefore not a chargeable event and no tax would be due.

Question 68

John and Betty have a large estate which will be subject to IHT on their deaths. They wish to ensure that their two children have the liquid cash to pay the bill and have taken out a whole of life policy. On what basis should this policy be set up? Two single life policies. Life of another. Joint-life, first-death. Joint-life, second-death.

Answer 68

Joint-life, second-death. John and Betty’s policy should be set up on a joint-life, second-death basis, subject to a suitable trust, so it bypasses their estate and leaves the monies directly in the hands of their children. They can then pay any IHT liability and release the estate.

Question 69

Peter has a life assurance policy in trust for his wife Belle, with his son, Tom, as a trustee. His daughter Laura is his attorney for his Lasting Power of Attorney. Who is responsible for notifying the life office of any changes on Peter’s policy? Peter himself, as the assured. Belle, as the beneficiary of the trust’s assets. Tom, as the legal owner of the trust’s assets. Laura, as she has power over Peter’s finances.

Answer 69

Tom, as the legal owner of the trust’s assets. Tom is the legal owner of the trust’s assets and as such is responsible for dealing with the life office regarding any changes on the policy.

Question 70

Chris has an onshore bond and is an additional rate taxpayer. The most tax she will pay on any gains is… 0%. 20%. 25%. 45%.

Answer 70

25% An onshore bond pays basic rate income tax internally. As an additional rate taxpayer Chris would therefore be subject to an extra 25% income tax on any gains made. It offshore it would be 45%