Policy proposals described by HM Revenue & Customs as “a consultation on possible alternatives to the current tax rules for part surrenders and part assignments of life insurance policies” could tear apart the existing system of 5% withdrawals from insurance bonds.
That is one of the fears being expressed, following the announcement by the UK government that it is setting out to review the rules, following a spate of incidents in which tax liabilities were applied, amid claims that the existing rules were not sufficiently clear.
In a policy document published Wednesday, Part surrenders and part assignments of life insurance policies HMRC sets out three possible alternative options to the current system:
- Taxing the economic gain
This option looks to calculate the economic gain on each withdrawal by treating some of the withdrawal as premium, and not treating it all as gain. This therefore ensures the amount of tax chargeable is an appropriate fraction of the policy’s economic gain.
- The 100% allowance
This will replace the current allowance for someone to withdraw 5% tax free each year. The 100% allowance will enable someone to withdraw any amount at any point, up to 100% of their premium before being liable to tax. Once someone withdraws 100% of premium, excess withdrawals are then taxed as economic gains.
- Deferral of Excessive Gains
This involves keeping the current process in place, but including a benchmark for what is deemed an acceptable level of gain (eg, 3%). So if large sums are withdrawn, a safety net kicks in to ensure no disproportionate tax consequences occur, and the gain rolls on to the next withdrawal point. If the gain is still excessive, it will roll on again, and so on, up to maturity or full surrender.
According to Rachael Griffin, financial planning expert at Old Mutual Wealth, the proposals suggest that HMRC is looking to go beyond finding a solution for what has been a relatively low number of problematic tax liability cases – some 600 are cited by the tax authority.
“Two of the proposals; taxing the economic gain and deferral of excessive gains, both require complex calculations, and will impact all customers looking to make a withdrawal from their policy. It will make the withdrawal process more complicated and given some customers don’t fully understand today’s process I would argue it doesn’t help solve the issue.
“The simplest of the three options proposed is the 100% allowance. Customers are already familiar with the 5% withdrawal allowance on bonds, so a 100% allowance would be easy to understand and does not require any additional complex calculations. It could also benefit customers as it would provide them with increased flexibility to withdraw over 5% a year if required, without creating any tax liability.”
HMRC’s consultation document makes clear that it forms the second stage of a five-stage process that would lead to implentation of new tax policy. These steps are:
Stage 1 Setting out objectives and identifying options.
Stage 2 Determining the best option and developing a framework for implementation including detailed policy design.
Stage 3 Drafting legislation to effect the proposed change.
Stage 4 Implementing and monitoring the change.
Stage 5 Reviewing and evaluating the change.
“This consultation is taking place during stage 2 of the process. The purpose of the consultation is to seek views on the detailed policy design and a framework for implementation of a specific proposal, rather than to seek views on alternative proposals,” HMRC states.
Any responses to the consultation should be sent by 13 July 2016, by e-mail to: [email protected] or by post to:
HM Revenue and Customs
100 Parliament Street