Introduction

An insurance bond is a single premium life assurance policy which, as well as paying out a lump sum on either surrender by the policyholder or the death of the life assured, also contains investment assets. The insurance element of the bond may be minimal, but where there is any element of insurance, the taxation of the entire policy is subject to the rules which apply to insurance policies. These rules mean that the taxation of income and gains may be deferred until encashment of the policy or other chargeable event, at which point any gain will be subject to income tax. 

This note sets out a high-level overview of the UK tax position of individuals who invest in insurance bonds personally. The note also briefly comments on the tax position of settlors of trusts holding insurance bonds. Taxation of insurance bonds is a complex area and, as this note is necessarily high-level, it is not a comprehensive analysis of this topic. 

Insurance bonds are investment products. It is essential that appropriate investment advice is taken, in addition to tax advice. 

Types of investments 

There are two types of insurance policies that provide investment returns; ‘with-profits’ and ‘unit-linked’ policies. With profits policies pay returns to investors based on the performance of the life assurance company. Unit-linked policies are more akin to investment portfolios, as the amounts paid on surrender or maturity of the policy depend on the value of the underlying investments. The type of policy to be taken should be discussed with an appropriate investment advisor. This document considers the tax position of unit-linked policies. 

Insurance bonds can contain a range of investments, but it is generally advisable from a tax perspective for the investments held within the policy to be ‘collective investment schemes’ and/or for the policyholder to have minimal control over the precise investments which are made. This is because if certain types of assets are held within the policy (such as owning shares in a specific company) at the behest of the policyholder, the policy may be classed as a ‘personal portfolio bond’. 

Personal portfolio bonds are subject to a punitive tax regime. Policyholders are personally taxable on a deemed 15% return on the amount invested each year, on a cumulative basis. The remainder of this note deals with bonds which are not personal portfolio bonds. 

Ongoing taxation of the policyholder

Provided the policy is not a personal portfolio bond, the policyholder is not taxable personally on income or gains made within the policy. Instead, taxation is deferred until encashment of the policy or other chargeable event, as set out below.

Withdrawals 

The policyholder can withdraw 5% of the premiums paid into the policy each year without an immediate tax charge, up to a maximum withdrawal of 100% of premiums paid after twenty years. Withdrawals can be made cumulatively, so if no withdrawals are made in the year the policy is taken out, 10% of the premiums paid into the policy can be withdrawn in year two (2 x 5%). 

If withdrawals are made in excess of the available 5% allowances, any excess withdrawn from the policy will be regarded as a chargeable event gain and taxed accordingly, regardless of the performance of the underlying investments. For this reason, investments into insurance bonds are generally split into a number of policies so that withdrawals can be made more flexibly. 

Encashment, maturity and other chargeable events

The bond can be surrendered at any time, subject to any terms imposed by the insurer. Broadly, the policyholder should receive the value of the underlying investments to which the policy is linked. 

Chargeable event gains are calculated when a chargeable event occurs. ‘Chargeable event’ is defined as including surrender/ encashment, maturity, death giving rise to a benefit and assignment for money or money’s worth. Except for chargeable event gains that occur when more than the available 5% allowances are withdrawn from a policy, chargeable event gains are, broadly, equal to the total amount received from the policy (including earlier withdrawals), less premiums paid and any earlier chargeable event gains which have been taxed. 

For example, if premiums of £100,000 are paid into a policy, £20,000 is withdrawn over the life of a policy within the available 5% allowances and £130,000 is received on surrender of the policy, the chargeable event gain is £50,000 (£130,000 received on surrender + £20,000 withdrawn - £100,000 premiums paid).  

Gift of a policy for no consideration and assignments between spouses or civil partners who are living together are not chargeable events. 

Taxation of chargeable event gains 

Chargeable event gains are subject to income tax at the policyholder’s marginal tax rate. If the individual is subject to more than one rate of income tax on the gain (say part of the gain is subject to basic rate tax and the remainder of the gain is subject to higher rate tax) and the policy was held for more than a year before the chargeable event, ‘top slicing relief’ may be available to reduce the amount of gain subject to higher rate tax. 

Top slicing relief provides relief for taxpayers who have abnormally large income in one tax year due to making a chargeable event gain, by effectively calculating the tax due as if the gain was spread over a number of tax years. For example: 

• An individual encashes an insurance bond he has held for two complete years; 
• A chargeable event gain of £20,000 is made, and;
• There are no previous chargeable event gains (i.e. no withdrawals in excess of available 5% allowances were made). 

If the individual concerned has £10,000 basic rate band remaining, in the absence of top slicing relief £10,000 of the gain would be subject to basic rate tax (£10,000 x 20% = £2,000) and the remaining £10,000 of the gain would be subject to higher rate tax (£10,000 x 40% = £4,000). The total tax liability would be £6,000. 

Where a policy has been held for two complete years top slicing relief effectively doubles the amount of basic rate band available, in this example to £20,000 (2 x £10,000). Therefore the entire £20,000 gain would be subject to basic rate (20%) tax, resulting in a total tax liability of £4,000. 

The above figures are illustrative, and assume the simplest possible top slicing calculation applies. The calculation may be more complicated in practice, due to complexities in the income tax computation. 

UK or overseas policy

A notional 20% tax credit is normally available where a chargeable event gain arises on a UK insurance policy. This tax credit is intended to effectively provide relief for UK tax paid on income and gains within the policy on an ongoing basis by the UK based insurer which issued the policy. As the 20% tax credit is notional, it will not be repaid if it exceeds the amount of tax due. In the above example, as the entire £20,000 gain was subject to 20% taxation, the £4,000 tax liability would be equal to the 20% (£4,000) tax credit on a UK policy, and so the individual would not have a further tax payment to make to HMRC. 

In general, no tax credit is available in relation to foreign policies. There is a limited exception from this for insurers situated elsewhere in the European Economic Area (EEA) who have paid an amount of tax which is, broadly, equivalent to the amount of tax a UK insurer would have paid. Assuming that the tax credit is unavailable in the above example, this means that the individual would need to pay £4,000 to HMRC in respect of the tax due on an offshore policy.  

HMRC are also able to extend the notional tax credit to gains realised on insurance policies issued outside of the EEA if they wish to do so, though have not done so to date. 

Losses

In general, loss relief is unavailable on losses realised on insurance bonds. Limited relief may be available in some cases if a chargeable event gain previously arose on a withdrawal in excess of available 5% allowances, if the policy is standing at an overall loss when it is later encashed or certain other chargeable events occur.  

International aspects 

Non-UK domiciled individuals 

Chargeable event gains are not eligible for the remittance basis. Chargeable event gains realised by UK resident, non-UK domiciled individuals are taxable, regardless of whether the policy is UK or foreign. This includes the 15% deemed gain made each year on personal portfolio bonds. 

Non-UK domiciled individuals who are not deemed to be UK domiciled for inheritance tax purposes are only within the scope of UK inheritance tax on UK situated assets and certain foreign assets that derive value from UK residential property. UK policies are usually UK situated assets. Foreign policies may be outside of the scope of inheritance tax while the individual remains non-UK domiciled, both legally and for inheritance tax purposes.   

Internationally mobile individuals

In general, individuals are only subject to income tax on chargeable event gains if they are UK resident on the date of the chargeable event. Accordingly, non-UK residents are typically not chargeable on chargeable event gains. However, individuals who were previously UK resident may be chargeable on chargeable event gains realised during a period of temporary non-UK residence on return to the UK, if certain conditions are met.  

If the individual subject to taxation on the gain has been non-UK resident for part of the period in which the policy is held, the gain may be pro-rated between resident and non-UK resident periods, and income tax only applied to the gain attributable to the period of UK residence. 

A number of changes were made with regard to the taxation of internationally mobile individuals who realise chargeable event gains with effect from 6 April 2013, and so the exact position will vary depending on when a policy was taken out, where the policy is situated and whether a non-UK resident period commenced before or after 6 April 2013.

Trusts 

The comments made so far in this note have focused on the tax position of individuals who own policies personally. A further point to consider is that UK resident individuals who have settled assets on trust are personally taxable on chargeable event gains made by the trustees, regardless of whether or not the settlor has or could benefit from the trust. The settlor may be able to recover the tax payable from the trustees.