When is life insurance taxable? What type of policy makes the most sense when you include tax impact?
Normal life insurance policies taken out by a private person, designed to make a payment upon the death of a policyholder, are not taxable - there is no tax on the payment, and no tax relief on the premiums.
Some policies, which are technically life insurance policies but are taken really for savings purposes (such as endowment plans, for example) can sometimes be taxable if they are surrendered early - and the gain from single-premium investment bonds can also lead to a tax charge (under some circumstances). Technically, such plans do indeed fall under the life insurance rules.
An area where tax may apply is where a business takes out insurance on its employees (directors or otherwise). This is a big topic, but if the insurance is for the benefit of the employee - for example, to provide critical illness cover, then the premiums will be treated as part of employee remuneration, then taxed accordingly. It can also be the case that the business pays for the cover in order to provide a benefit such as, for instance, long-term 'sick pay'. According to the way the policy has been set up, the business may claim the monthly premiums as an expense, hence get tax relief, but the benefits will become taxable revenue in the hands of the company. Of course, if the company balances that revenue by paying it out to the employee, then it is the employee who will have an income tax burden to meet. | 01.09.11 @ 17:18
Ah yes - but there is another point! If the life cover is not paid 'in Trust', then the benefit payment will enter the policyholder's estate. If this brings the estate above the inheritance tax nil-rate band (currently £325,000) then it will be subject to a very large inheritance tax bill: a substantial 40% above the threshold (I have not discussed ways of reducing IHT, which is outside the scope of this question.
Simple solution: ensure that all life policies are written in Trust, or if they already exist, are placed into Trust. This is straightforward and normally free (use the life company's own forms) and not only avoids this particular IHT trap, but also would speed payment in the event of a claim. | 01.09.11 @ 17:24
David's spot on. Let me give you an example. One of my clients died last January. She had assets after debts were taken off of about £325,000, which is, by coincidence,is the same amount as the Inheritance Tax Threshold. I proposed a life policy for £300k and placed it into trust for her partner about a year prior to her death. When she died, her 3 children decided to appoint a solicitor to administer her affairs and their charges were 3% of the estate.
Margaret died on 18th Jan and her partner produced the death certificate on the 20th. The insurance company paid him £300k on the 24th, the day before her funeral - no tax! If we hadn't placed the plan into trust, I don't think the partner would have received much of the money from this plan as the children would have been entitled to it.
Alos, if I hadn't placed this plan into trust, Margaret's estate would not only have to find £120k to pay the tax, but also the solicitor would charge 3% as well, another £9,000. The trust document took me 10 minutes max to complete and saved them £129k.
The remaining estate took until November to resolve and because they had to go to probate, if the life plan wasn't in trust, it would have been likely that the plan wouldn't have paid until then.
Hopefully this answers your question on tax impact and as to the type of plan, assuming you are below retirement age, I would suggest a term assurance plan | 01.09.11 @ 19:42
I agree with both of David and Paul's comments above which echo sentiments i have left in response to other insurance related questions on this site.
Paul's example is a prime reason for people to take independent financial advice. Although i don't know Paul, or what he charges for his services, I can state with great confidence that his client's family are substantially better off having taken advantage of his skills. | 01.09.11 @ 21:45
Hi Darren. I never charge anything for setting up a trust like this, mostly because I feel its our oral duty to do this for our clients.
I did, however, charge the clients for sorting out their mothers financial affairs. Even though this took several months, it did speed up the whole process. People seem to forget, and this certainly was evident in this case, that solicitors aren't financial advisers and most are at loss with a lot of financial matters and are, at times, at loss of where to go and who to approach.
I will admit though, that I am at loss with a lot of the legal process. | 01.09.11 @ 21:58
Just to make you aware, on line 2 "oral" should have said moral | 01.09.11 @ 21:59
A bit off-topic, but for any non financial advisers out there, I think that Paul is being somewhat modest about his approach to the work. All competent financial advisers have some knowledge of the law, particularly as it relates to financial matters - and I would be surprised if Paul, like me, has not from time to time outlined information for a Solicitor, whose knowledge is occasionally very basic on such issues. The three professionals who may have impact on an individual's financial affairs - Solicitor, Accountant, and Financial Adviser - have complementary, occasionally overlapping but essentially different specialisms.
| 01.09.11 @ 22:07