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Non-qualifying life assurance policies are taxable. Most policies are 'qualifying' and are not taxable.
The basic principle behind these policies, sometimes called bonds, is that an amount of money is invested for a period typically of 10 or 20 years. The policy is cashed in at the end of this period and the gain is taxed. There are two data entry sections in IRIS. The detail option requires that the full history of the policy be entered (amounts paid, full history of all withdrawals), IRIS will then compute the chargeable gain and the term for top-slicing relief. The chargeable event certificate option takes the information directly from a chargeable event certificate issued by the life assurance company. It will show the chargeable gain and the term.
5 - Multiple Life Assurance Gains
Nearly all life assurance gains are deemed to have been taxed at the basic rate and the only liability is to tax at the higher rate. This is achieved by inserting a notional tax credit at 22% of the the taxable gain. For example, if there is a gain of £1,000, the notional tax will be £220, a higher rate taxpayer would have to pay tax of £180 to bring this up to the full 40% rate, a basic, lower or non-taxpayer will have nothing more to pay. The notional tax is not refundable so lower rate and non-taxpayers cannot receive a refund of the notional tax on the life assurance gain.
It is possible to withdraw income from the policy. Any amount up to 5% of the amount paid is not taxed when the withdrawal is made. If more than 5% per annum is withdrawn the excess is taxed. This is called a chargeable event on partial surrender. The 5% 'allowance' is cumulative. Therefore, if no withdrawal is made in one year, up to 10% may be withdrawn in the following year without charge. For example, if a policy is purchased for £10,000 on 1/1/95, £500 may be withdrawn each year without charge to tax:
Year ending Withdrawn AAA RAV Gain
|
31/12/95 31/12/96 31/12/97 31/12/98 |
0 500 750 1,000 |
500 1,000 1,500 2,000 |
0 500 1,250 2,250 |
0 0 0 250 |
In the 1998-99 year there will be a chargeable event of £250. The term for top-slicing relief will be 4 years. AAA stands for Allowable Aggregate Amount; it is the maximum cumulative withdrawal that may be made. RAV stands for Reckonable Aggregate Value and is the total amount withdrawn since the last chargeable event. Both the AAA and the RAV are reset to zero when a gain arises.
The term (4 years in the example above) is the number of complete years that the policy has run since purchase or the preceding chargeable event. To continue the example, above, if the taxpayer withdraws another £1,000 in the year ending 31/12/99, there will be a chargeable event gain of £500 with a one year term in 1999-2000:
Year ending Withdrawn AAA RAV Gain
|
31/12/98 31/12/99 |
1,000 1,000 |
2,000 500 |
2,250 1,000 |
250 500 |
When the policy is encashed (chargeable event on encashment), the following formula is used to compute the gain:
Amount received on encashment n
plus sum of all withdrawals n
less amount paid (n)
less gains on partial withdrawals (n)
----
Chargeable gain n
Continuing the example above, the policy is encashed on 31/12/00 for £20,000, no other withdrawals are made after 31/12/99:
|
Encashed for Plus all withdrawals Less amount paid Less previous chargeable gains
Chargeable gain |
20,000 3,250 -10,000 -750 ---------- 12,500 |
The term of the gain will be for the whole life of the policy, 6 years in this example.
The purpose of top-slicing relief is to relieve higher rate tax suffered when the life assurance gain forces the taxpayer into the higher rate tax band. If it the gain accrued over two or more years, top-slicing relief may be available.
The basic calculation for top-slicing relief is:
A, B and C above represent the tax due in each computation.
Top slicing relief = (A - B) - ( (C - B) x term )
(A - B) is the tax on the whole life assurance gain. (C - B) is the tax on one year's worth, multiply this by the term to arrive at the tax that should be paid on the whole gain. The difference between these figures is the top slicing relief.
Top-slicing relief = (tax on whole life assurance gain) - (tax on one-year's worth x term)
For example, a taxpayer has taxable income of £30,000 including £3,000 life assurance gain with a 3 year term in 1999-2000.
|
|
A |
B |
C |
|
Taxable income £1,500 @ 10% £26,500 @ 23% £25,500 @ 23% £2,000 @ 40%
Tax borne (due) |
30,000 150.00 6,095.00
800.00 ------------- 7,045.00 |
27,000 150.00
5,865.00
------------- 6,015.00 |
28,000 150.00 6,095.00
------------- 6,245.00 |
Top slicing relief = (7,045 - 6,015) - ( (6,245 - 6,015) x 3)
= 1,030 - (230 x 3)
= £340
Note that, in this case, the £2,000 initially taxed at 40% is now effectively taxed at 23% (2,000 @ 23% = £460 which is the same as 800 - 340 = £460). Top-slicing relief will not always give full relief for higher rate tax. If one-year's worth of the gain is partly taxed at 40% then the top-slicing relief is reduced. For example, by slightly changing the example above so that there is £30,500 of taxable income including £3,000 life assurance gain with a 3 year term:
|
|
A |
B |
C |
|
Taxable income £1,500 @ 10% £26,500 @ 23% £26,000 @ 23% £2,500 @ 40% £500 @ 40%
Tax borne (due) |
30,500 150.00 6,095.00
1,000.00
------------- 7,245.00 |
27,500 150.00
5,980.00
------------- 6,130.00 |
28,500 150.00 6,095.00
200.00 ------------- 6,445.00 |
Top slicing relief = (7,245 - 6,130) - ( (6,445 - 6,130) x 3)
= 1,115 - (315 x 3)
= £170
The top-slicing relief is lower in this example because one-year's worth of the gain is taxed partly at 40%.
The calculation of capital gains tax may also be affected by top-slicing relief.
If there are two or more life assurance gains, the gains are added together to form a single total. One-year's worth of the gain is calculated by dividing each gain by its term and adding up the total. A composite term must then be computed.
For example two life assurance gains, one for £10,000 over 5 years and the other £9,000 over 3 years:
|
10,000 / 5 = 9,000 / 3 =
one-years worth = |
2,000 3,000 -------- £5,000 |
The term is computed by dividing the total gains by one-years worth: 19,000 / 5,000 = 3.8 years.
