Orlando Harmon
Life insurance is a valuable financial product that provides financial security to loved ones in the event of an untimely death. While the primary purpose of life insurance is to offer protection, it can also be used as an investment vehicle. When a life insurance policy is cashed in, sold, or matures, it may result in a chargeable event gain, which is subject to taxation. This gain is not considered a capital gain but is instead taxed as income. The taxation of these gains depends on whether the life insurance policy is a qualifying or non-qualifying product, with the latter being more common and including single premium bonds, guaranteed income bonds, investment bonds, or property bonds. The chargeable event gain on non-qualifying policies is typically taxed as savings income, attracting a 20% tax credit. It is important to understand the tax implications of life insurance policies to ensure compliance with HMRC regulations and avoid common tax pitfalls.
What You'll Learn
Chargeable event gains are not capital gains
If you receive a payment or other benefit from a life insurance policy, you may have made a chargeable event gain. The type of policy you have and the amount and type of payment or benefit received will determine whether you need to pay any income tax.
For tax purposes, the most important distinction is between 'qualifying' and 'non-qualifying' life insurance policies. Qualifying policies usually do not give rise to a chargeable event gain, whereas non-qualifying policies often do. Qualifying policies generally have a minimum term of 10 years with fairly even premiums payable at regular intervals. If your insurer has sent you a chargeable gains certificate, it could be because your policy has been surrendered or premiums have ceased within the first 10 years, or for other reasons outlined by your insurer.
Non-qualifying policies are all policies that are not qualifying policies. These are often single premium life insurance policies, although additional premiums may be allowed. Personal Portfolio Bonds (PPBs) are another type of non-qualifying policy that gives rise to an annual charge.
If you are unsure about what type of policy you have, whether there has been a chargeable event gain, or whether tax is treated as paid, you should contact your insurer.
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Qualifying vs non-qualifying policies
A chargeable event gain occurs when there is a gain on a life insurance policy. This can happen when there is a partial surrender over certain limits, policy loans after 26 March 1974, or assignment for money or money’s worth, among other reasons.
Qualifying policies are life insurance policies with a special tax status. This means that the proceeds are free of tax for the beneficiary providing the policy is held to maturity. Normally, a qualifying policy would be an endowment plan held with a life insurance company or friendly society, with fixed premiums over a term of at least 10 years.
Non-qualifying policies, on the other hand, do not have this special tax status. All offshore policies are non-qualifying by default, and non-qualifying policies are often set up as a wrapper for investments rather than purely to provide life cover. Single premium investment bonds, both onshore and offshore, are non-qualifying. Onshore non-qualifying policies give rise to chargeable events in the case of death if it results in a benefit, a partial surrender over certain limits, policy loans after 26 March 1974, or assignment for money or money’s worth.
In the context of life insurance distributions, a qualified plan refers to an employer's plan that meets specific Internal Revenue Code requirements and may qualify for special tax benefits. Non-qualified plans, on the other hand, are those that are not eligible for tax-deferral benefits, such as public sector plans.
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Single Premium Life Assurance (SPL)
The main benefit of SPL is that it provides permanent life insurance coverage with a guaranteed death benefit in exchange for a one-time lump-sum payment. The policyholder's beneficiaries will receive a sizable payout due to the lump-sum funding, and this death benefit is tax-free. Additionally, the policyholder can access the cash value of the policy through loans or withdrawals during their lifetime. The cash value of the policy grows over time and can be borrowed against.
SPL policies are typically classified as Modified Endowment Contracts (MECs), which have specific tax implications. Withdrawals and loans from MECs may be taxed as ordinary income, and if the policyholder is under 59 1/2 years old, they may also be subject to a 10% penalty.
SPL policies are not suitable for everyone. The large upfront payment required to fund the policy may be a financial burden for many individuals. Additionally, SPL policies do not allow for additional contributions, and there are high surrender charges if the policy is cancelled early.
SPL policies are often favoured by high-net-worth individuals for their accumulation benefits and are particularly useful for those looking to maximise their investment quickly.
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How to calculate a gain
The amount of gain will usually be shown on a certificate sent to the policyholder by the insurer. This certificate should also show whether tax is to be treated as paid on the gain and the number of complete policy years that the policy has run from commencement or from the previous gain.
If you have not received a certificate, it is likely that you did not make a gain. This could be because of your type of policy, for example, it is a qualifying policy, or what you did, for example, you assigned your policy as a gift. Alternatively, the amount of benefit received did not give rise to a gain.
However, there are some circumstances in which a gain may have been made without a certificate being issued. For example, the insurer may have sent the certificate to the wrong person or address, or they may not know about the event that gave rise to the gain. In these cases, you should contact the insurer to request a certificate.
If you have a certificate, the following information will help you understand the calculation of a gain.
On Maturity or Full Surrender
A gain on maturity or full surrender should be shown on the certificate provided by your insurer, along with the amount of income tax treated as paid. If not, it can be calculated using the following formula:
> TB minus (TD plus PG)
- TB is generally the value of what you receive on maturity or full surrender, plus the value of what has been received previously under the policy (excluding critical illness or disability benefits).
- TD is generally all amounts paid as premiums under the policy.
- PG is all gains that were someone's income for tax purposes in a previous tax year.
On Death
Calculate a gain on death using the same formula as for maturity or full surrender, but in this case, TB is the surrender value of the policy immediately before death rather than the amount received as a result.
On the Sale of All of a Policy
Calculate a gain on the sale of an entire policy using the same formula as for maturity or full surrender, except that in this case, TB is normally the sale price of the policy or the value of any other consideration. If the sale is between connected persons, for example, a brother and sister, TB is the market value of the policy. However, the transfer of ownership between spouses or civil partners who are living together does not give rise to a gain.
On Part Surrenders or Part Assignments (Sales)
Gains from part surrenders and part assignments of life insurance policies are calculated annually and arise at the end of each insurance year. The gain for an insurance year when there has been one or more part surrenders is calculated as follows:
> The value of all parts surrendered less unused one-twentieth of the premiums paid in the year and each previous year. This is subject to a maximum of 100% of the premiums paid (which will be reached if 5% of the premiums are taken for 20 consecutive years). For part assignments, the calculation is the same, except that TB is the value of the part sold rather than the part surrendered.
If, following a part surrender or part assignment of a policy, the persons liable to tax on the gain consider that the gain arising is wholly disproportionate, they can apply to HMRC to have the gain recalculated on a just and reasonable basis.
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Tax reliefs
A chargeable event gain occurs when there is a payout or other benefit from a life insurance policy. This can happen when a policy is surrendered, or premiums cease within the first 10 years of the policy, the policy matures or ends due to the death of the insured, or the policy is sold or assigned.
Chargeable event gains are taxable as income, and the tax is treated as paid at the basic rate. If the gain pushes the recipient into a higher tax bracket, they may need to pay additional tax. This is known as Top-Slicing Relief.
Top-Slicing Relief is generally available when you pay:
- Basic-rate tax on your other income, excluding the gain, but when the gain is added to your other income, you have to pay a higher or additional rate of tax.
- Higher-rate tax on your other income, excluding the gain, but when the gain is added to your income, you have to pay an additional rate of tax.
In order to calculate the amount of relief, you will need to know the number of complete years the policy has been held. This should be stated on the chargeable event certificate that the insurer must send you.
The calculation of Top-Slicing Relief can be complicated, and it is not possible to give full details here. However, the following example provides some clarification.
Let's say you have a life insurance policy that pays out £10,000. The premiums paid total £4,000. In this case, the gain is £6,000 (£10,000 - £4,000). If this gain pushes you into a higher tax bracket, you may be able to claim Top-Slicing Relief, which will reduce the amount of tax you owe.
It is important to note that chargeable event gains are not capital gains, so capital losses and the annual exempt amount cannot be set against them. Additionally, if a policy is written in trust, it is the trustees' responsibility to deal with any Inheritance Tax (IHT) liability that arises from the proceeds paid to the trust fund.
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Frequently asked questions
A chargeable event is when a gain arises, for example, if during the year there was a full or part surrender of a policy, a policy matured or was brought to an end by the death of the life insured, there was a sale or assignment of a UK policy, or the policy was a PPB.
A chargeable event gain is a gain that arises from a chargeable event. It is taxable as income, although tax at the basic rate may be treated as paid on the gain.
If you are already within Self Assessment, report the gain in your Self Assessment return. If you are not within Self Assessment but the gain exceeds £10,000, you will need to register for Self Assessment and report the gain in your Self Assessment return. If you are not within Self Assessment and the gain does not exceed £10,000, you should report it by contacting Self Assessment: general enquiries or sending a copy of the chargeable event certificate to Self Assessment, HM Revenue and Customs, BX9 1AS.
A chargeable event gain certificate is a certificate that UK insurers are required by law to issue if they know that a gain has been made on a life insurance policy. The certificate should show the gain that has arisen, whether tax is to be treated as paid on the gain, and the number of complete policy years that the policy has run.
If you have not received a certificate, it may be because you did not make a gain, or because the insurer has sent the certificate to someone else or the wrong address. If you believe you have made a gain but have not received a certificate, you should check with the insurer to see if they have sent the certificate to someone else or the wrong address.
