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Policyholder tax

M

Mbotha

Member
For life assurance contracts, tax is payable on the chargeable gain = benefit - less total premium paid. In the case of part surrenders, the chargeable gain is calculated as:
  • (partial) surrender benefit less
  • the sum over all years t of P x 0.05 x t, where t is the time at which the policy is partially surrendered
So if the premiums were £10 p.a. and the policy is partially surrendered at time 3 then the second part of the equation (second bullet point) would be
(10)(0.05)(1) + (10)(0.05)(2) + (10)(0.05)(3)

Why is it calculated as above rather than just taking 5% of all premiums paid?
 
In this same section in chapter 5, it states that "surrender of bonus on a qualifying policy counts as a part surrender". Why is this not also the case for non-qualifying policies?
 
Mbotha said:
For life assurance contracts, tax is payable on the chargeable gain = benefit - less total premium paid. In the case of part surrenders, the chargeable gain is calculated as:
  • (partial) surrender benefit less
  • the sum over all years t of P x 0.05 x t, where t is the time at which the policy is partially surrendered
So if the premiums were £10 p.a. and the policy is partially surrendered at time 3 then the second part of the equation (second bullet point) would be
(10)(0.05)(1) + (10)(0.05)(2) + (10)(0.05)(3)

Why is it calculated as above rather than just taking 5% of all premiums paid?
Click to expand...

This is because the tax relief is 5% per annum. So for example for a premium paid five years ago, 5% x 5 years = 25% of this premium can be part surrendered without tax. [And yes, your calculation is correct]
 
Oh, I see. Thanks, Lindsay.

I'm also hoping you may be able to help me with my other question:
Mbotha said:
In this same section in chapter 5, it states that "surrender of bonus on a qualifying policy counts as a part surrender". Why is this not also the case for non-qualifying policies?
Click to expand...
 
Actually I don't see why it wouldn't be the case for non-qualifying policies too, so I am not sure why that wording was chosen for the Core Reading. Perhaps the only policies on which bonuses can be surrendered happen to be qualifying ones? I wouldn't worry too much about this kind of detail - just need to have understanding that surrender of bonus is a type of partial surrender, and about how partial surrenders are taxed.
 
Hi, yet another question from Ch 05 on Policyholder Tax.

Question 1

Section 2.2 states that the limit on premiums for qualifying policies is 3600 gbp. This is a rule for policies issued after 5 April 2013.

In a real world, my interpretation would be that the company would still accept larger premiums but would issue 2,3 etc policies - multiple records....A policyholder would then end up keeping several policies for smaller premiums to benefit from tax.

Is that correct?

Question 2

section 3.1 of the core reading "In the case of immediate annuities, they are often referred to as purchased life annuities to indicate that they are taken out at the discretion of the policyholder"

What does the discretion in this sentence indicate (ie. regarding taxaation)? The core reading goes on saying that the deferred annuities are treated as non-qualifying life assurance policies.
 
Last edited by a moderator:
Lindsay Smitherman said:
Hi: the limit applies to the total of annual premiums payable across all qualifying policies held by an individual.
Click to expand...

Thank you Lindsay. This makes sense as the tax limit applies per individual and works across all qualifying policies.

In which circumstances the company would set up multiple policies for tax reasons? I have read about this in chapter 1.
 
Do you mean the "clustering" of policies mentioned in Chapter 4? This was done to make it easier to part surrender the overall investment (by fully surrendering individual policies within the cluster) and it made sense due to legislation and tax treatment in force at that time. However, this approach is no longer necessary and, as stated in the notes, you don't need to know the details.
 
Lindsay Smitherman said:
Do you mean the "clustering" of policies mentioned in Chapter 4? This was done to make it easier to part surrender the overall investment (by fully surrendering individual policies within the cluster) and it made sense due to legislation and tax treatment in force at that time. However, this approach is no longer necessary and, as stated in the notes, you don't need to know the details.
Click to expand...

I think the core reading mentions something about tax treatment in product description (ch 1 and ch 2). I will find the detailed paragraph later on this evening.

Also, I have seen in practice that companies would create multiple records under one policy number when the policyholder buys more covers or his/her premiums increase. I was under impression that this is done for tax reasons i.e. it is more optimal to create additional "small policies" rather than one large record.
 
Hi Lindsay, the multiple records are set up for mortgage endowments in order for the policy to be qualifying. If policyholder has 1 limit for premiums why would a company set up multiple policies?
 
Hi - are you referring to the point made in the Core Reading (Chapter 2 Section 1.1) about setting up a premium increase as a separate increment policy in order to retain qualifying status?

This isn't to do with the total premium limit, it is in order to avoid breaking the qualifying rule about the level of premiums not increasing by more than a certain amount over the term of the policy.
 
Back on the first question in the case of the partial surrender and the 5% thing.

The wording around chargeable gain is "less TOTAL premium paid" so just to clarify, this is much much less than total premium if it's 5% p.a. as above.

The original response confused me as this system is presented as a good thing but it's actually fairly little tax relief... Is that correct understanding and therefore the point is that if you're surrendering, you don't get much tax relief especially if it's early on?
 
On full surrender, the chargeable gain is the benefit paid to the policyholder minus the total premiums that have been paid by the policyholder. Early on, the amount of surrender value is unlikely to be much (if at all) in excess of the total premiums paid up to the surrender date and so the policyholder is gaining fairly high tax relief if considered as a proportion of benefit received.

On part surrender, the 5% rule broadly means that the policyholder can withdraw a tax-free income of 5% of premiums paid each year. If they subsequently surrender, the chargeable gain is basically as for a normal surrender but allowing for the amounts already paid out and the tax relief already given.

Bear in mind also that (for BLAGAB policies other than general annuities) tax is only payable at the policyholder's marginal rate minus base rate, thus only payable by higher rate taxpayers.

Hope that helps.
 
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