‘My wife cashed in her life assurance policy – will she have to pay tax?’
Email your tax questions to Mike via email: taxhacks@telegraph.co.uk
Dear Mike,
My wife (aged 82) cashed in her bond after 27 years, which Prudential has advised has created a “chargeable event” and issued a certificate showing a gain of £29,674, which is treated as having borne basic-rate income tax.
Her modest annual income is an annuity paying £1,776 and state pension income £5,836. We estimate that this tax year she will receive interest outside her Isa of around £9,000.
Currently, she pays no income tax and HM Revenue and Customs advised some years ago that she no longer needed to complete a tax return.
I understand that as the chargeable event will not cause her income this year to reach the starting rate for higher-rate tax there will be no additional tax to pay.
If we have underestimated the anticipated savings interest received in the current year and the higher tax level is breached, would any tax owed be based on any small excess, or the full £29,674?
John
Dear John,
The investment your wife had with the Prudential was a single premium life assurance policy, often referred to as an investment bond. I assume that she did not make any withdrawals in excess of 5pc a year on a cumulative basis.
When the policy was fully encashed the overall profit will have created the chargeable event gain you mention.
Although referred to as a gain, this is taxed as savings income rather than as a capital gain. As you have been advised, your wife is treated as if basic-rate income tax has already been paid by the Prudential.
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The way she will be taxed on the policy applies top slicing relief which, although favourable, is not straightforward. There are five steps to calculate her tax on the bond.
You start by working out the tax position excluding the policy gain. Your wife has other income totalling £16,612 from which she can deduct her personal allowance of £12,570. This leaves £4,042 on which tax is payable.
However, she will benefit from the £1,000 savings allowance, as well as the full £5,000 nil-rate savings band. This is because she has savings of over £6,000 and her total income is less than £18,570 (the personal allowance plus the savings allowance and the savings band), which is why she does not currently pay income tax.
Step two is to establish the overall profit, which Prudential say is £29,674. In step three you divide this by the 27 complete years of the policy to give £1,099.
For step four, you work out the additional tax, if any, when this amount is added to her other income. The final step is to multiply the resulting amount by the life of the policy, in this case 27 years. For your wife the additional £1,099 will all be within her nil-rate savings band, let alone her available basic-rate tax band, so there will be no additional tax for her to pay.
Policies can also be assigned, typically to your spouse. I helped my father assign several policies to my mother who, as a basic-rate taxpayer, was able to encash them with no resulting tax liability.
However, beware of partial surrenders of policy segments, which can result in dramatically inflated tax liabilities.
If you make a partial surrender of a policy, or an individual segment, and withdraw more than 5pc per annum on a cumulative basis, the excess is taxed as if it was income.
In effect, part of your original investment is treated as income and, in extreme cases, you may pay tax on more profit than the policy ever produced.
Handle with caution, and take advice if in doubt.
Mike
Dear Mike,
My partner and I have equity from our property sale as we are temporarily renting while we search for a new home.
We are planning to spread the money across easy-access savings accounts.
I pay basic-rate tax on my pension and my partner is not working at present.
Should we be mindful of paying more tax due my status if we choose joint accounts?
Caroline
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Dear Caroline,
You should each invest in separate accounts calculated with the capital split between you in the way which maximises your respective £1,000 savings allowances and £5,000 nil-rate savings bands.
If your husband has lower income than you, this will probably mean that he should invest most if not all of the available capital. If he is not working and has no income currently he could receive savings income of up to £18,570 before any income tax is due.
Mike
Mike Warburton was previously a tax director with accountants Grant Thornton and is now retired. His columns should not be taken as advice, or as a personal recommendation, but as a starting point for readers to undertake their own further research.
