Premium limitation on qualifying life policies and restricted relief qualifying policies - part 2

The questions relate primarily to the implications for qualifying policy status following a premium increase which may cause the £3,600 premium limit to be breached. Such a breach could result in the policy becoming a restricted relief qualifying policy (RRQP). This means that the benefits under the policy will not be fully relieved from income tax when a deemed chargeable event occurs.  In some circumstances a qualifying policy could also become a non-qualifying policy in which case the policy benefits would not benefit from tax freedom.

In contrast, under a non-qualifying policy, tax is charged on the gain at normal rates (40% and/or 45%) but with a 20% tax credit for the tax charged on the assets of the life fund. Therefore, personal tax on a non-qualifying policy is effectively charged at 20% and/or 25%, whereas on a qualifying policy personal tax would normally be nil.

Premiums that could be paid into qualifying policies before April 2013 were unlimited in amount. From that date total premiums payable by one individual, subject to various exceptions, have been restricted to £3,600 per annum if freedom from tax on a gain under a qualifying policy is to attract no personal tax.

Where total annual premiums paid by an individual exceed £3,600 per annum then a policy may be rendered non-qualifying or tax freedom restricted to part only of the gain. Such restricted policies are termed “Restricted relief qualifying policies” or “RRQPs”.

In this second article we consider the application of the £3,600 rules to “old policies” and “new policies.” Old policies are those taken out before 21 March 2012 (known as “protected policies”) and new policies are those taken out after 5 April 2013.  In the next article we will consider “transitional policies”, which are those taken out after 20 March 2012 (which was the date on which the new provisions were announced) but before 6 April 2013. 

As regards all 3 categories of policies identified above, the rules only apply to premium payments made after 5 April 2013.

1. Policies issued before 21 March 2012 – “Old policies”

• a) Generally

A qualifying policy issued before 21 March 2012 is known as a protected policy. Protected policies will not be affected by the annual premium limit unless:

• Under the general rule there is a significant modification of the policy on or after 21 March 2012 (see 2 (b) or;

• Under the general rule a policy is assigned on or after 6 April 2013 (see 2 c));

 

or

• Under the general rule a policy is inherited by an individual who doesn’t already hold an interest in the policy, following the death of another individual, who was a beneficiary under the policy, on or after 6 April 2013. This is called a “deceased beneficiary event” (see 2 d))

 

• b) Significant modifications

Where a protected policy is significantly modified on or after 21 March 2012 then, provided the resulting annual premiums do not exceed £3,600, the policy will remain a qualifying policy.

On the other hand, where a qualifying policy issued before 21 March 2012 (which is not an excluded policy ie policies excluded from the annual premium limit) is significantly modified on or after that date, that policy will become a RRQP from the date of the modification if the modification causes the annual premium limit of £3,600 to be exceeded.

Benefits deemed to arise from the full value of premiums payable in respect of the period from commencement to the date of the modification (or 5 April 2013 if later) will be tax free.

Any premiums payable from the date of modification (or, if later, 5 April 2013) will be taken into account for an individual’s annual premium limit.  The individual’s allowable premiums will therefore be restricted to a maximum of £3,600 per annum with effect from the date of modification (or, if later, 5 April 2013) or whatever shortfall is left from the annual limit once the individual’s other “new” qualifying policies issued before the modification are taken into account. 

 

A “significant modification” will take place where;

• there is a significant variation of the terms of an existing policy; or

• where a new policy is substituted in place of an existing policy and that substitution results in a significant variation of the terms of the existing policy.

 

For these purposes a “significant variation” will occur where a protected policy is amended to extend the period over which premiums are payable or to increase the total amount of premiums payable under the policy or both.  In addition, where the variation of the terms of a protected policy occurs after 5 April 2013, a significant variation will occur if the premium paying term is shortened, the total premiums payable decrease or both events occur.

A significant modification will not occur where the premiums payable under a policy are increased or the term of the policy extended and those alterations arise from provisions within the contract which existed before 21 March 2012 and which apply automatically. This means that those provisions arise automatically under the policy and they are not applied at the request of the policyholder or beneficial owner, or by the exercise of an option.

A significant modification will not occur where the only change is in the life assured under the policy.  Ordinarily, the substitution of one policy for another would be ignored if the only change was the life assured and the earlier policy had not matured. However, if this is not the only change and, say, premiums increase, then the beneficiary of the policy would need to consider the annual premium limit.

If the premium increase relates to an exceptional risk of death or disability specific to the individual insured then it can be ignored for the purposes of the premium limit. An example might be a policy for a deep-sea diver containing a specific premium loading. This would not be the case for a general, non-specific exclusion clause included in all policies. A loading because, for instance, the policyholder simply refused to undergo a medical, or gave an answer to a ‘lifestyle’ question that might indicate a higher risk, would not meet the condition and so the increased premium would be included in the premium limit.

A significant modification will be ignored if the effect of that modification is cancelled within 3 months of the day the modification occurred. This nullification of the modification will not in itself constitute a modification but is treated as if this change never took place. The policy reverts back to its original state prior to this change.

If instead of a cancellation described above, an individual decides to modify the policy again so that, for example, their premium limit is not breached but is reduced to the balance of £3,600 relief available, this is treated as another modification. The loss of qualifying status cannot be reversed in these circumstances and so the rectification provisions will not apply.

 

Example

Owen effects a 20 year savings plan for an annual premium of £3,000 on 1 August 2010. 

On 1 August 2012 he increases premiums, by agreement with the company, to £10,000 per annum.  This results in the policy becoming a RRQP.  On 1 August 2030 the policy matures for £250,000.

As the premiums are increased by Owen there is a significant moderation which means the £3,600 rules apply.

The total premiums payable under Owen’s policy are £186,000 – that is the two premiums of £3,000 paid before 6 April 2013 and the eighteen premiums of £10,000 (£180,000) paid since then.  The deemed chargeable event gain is therefore £250,000 less £186,000 = £64,000.

 

In light of this, it is then necessary to determine the premiums paid that attract tax relief. These will be

• £6,000 (2 premiums of £3,000 paid before 21 March 2012);

• £10,000 – the increased premium following the alteration that was paid on 1 August 2012; and

• £61,200 – being 17 premiums paid since 6 April 2013, £3,600 of each qualifies for relief.

 

The total of premiums that qualify for tax relief is therefore £77,200 and it is necessary to express this as a percentage of the total premiums paid to ascertain the proportion of the deemed chargeable event gain that will attract relief.

This will be £77,200 divided by £186,000 times £64,000 = £26,563.

Therefore the deemed chargeable event gain that is taxable will be £37,437 ie £64,000 less £26,563. 

 

• c) Assignments

Under the general rule the assignment of a qualifying policy before 6 April 2013 will not result in a change of status of that policy.

However, if a qualifying policy is assigned to someone else on or after 6 April 2013, the policy will automatically become non-qualifying unless it is an excluded assignment.  An excluded assignment is:-

• an assignment as part of a divorce settlement or dissolution of a civil partnership
• an assignment as a result of a court order
• an assignment as security for a debt or discharge of a debt
• an assignment between husband and wife and between civil partners
• an assignment into or out of a trust
• assignments to the personal representatives of a deceased individual or as a result of a deceased beneficiary event (see 2d).

The implications of making an excluded assignment after 5 April 2013

Whether the excluded assignment of a qualifying policy after 5 April 2013 will have an impact on the taxation of the proceeds of that policy will depend on the type of assignment that occurs.

 

The following assignments, which we have referred to as “exempted” assignments, have no impact upon a policy’s qualifying status :

• Assignments as a security for a debt or on discharge of a debt.

• Assignments as part of a legally enforceable obligation relating to a divorce or dissolution of a civil partnership if the policy assigned is to pay off an interest-only mortgage. 

• Assignments to personal representatives of a deceased individual.

• Assignments following the death of an individual if the beneficiary was already a beneficiary prior to death.

 

In all other cases, where a qualifying policy is assigned after 5 April 2013 the assignee must aggregate the premiums paid under the assigned policy with all of their other qualifying policies that are subject to the annual premium limit rules.  This will include all premiums payable in respect of existing qualifying policies issued after 5 April 2013 and any RRQPs. 

If the premiums payable under the assigned policy, when aggregated with the assignee’s other relevant qualifying policies (ie. policies issued after 5 April 2013 or RRQPs), do not cause the assignee to breach the annual premium limit of £3,600, the assigned policy will remain a qualifying policy in the hands of the assignee.

However, if the premiums payable under the assigned policy when aggregated with the assignee’s other qualifying policies cause the assignee to exceed the annual premium limit of £3,600 the status of the assigned policy will change.  The change will depend on the circumstances. As the assigned qualifying policy under consideration was issued before 21 March 2012 it will become a RRQP.   

 

• d) Deceased beneficiary event

Under the general rule a deceased beneficiary event occurs if, in connection with the death of one individual beneficiary, another individual who was not a beneficiary becomes a beneficiary under the policy. When the policy rights pass to the new beneficiary the annual premium limit will then be tested in respect of that new beneficiary.

This contrasts with the case where the policy passes to someone who was already a beneficiary under that policy (e.g. a joint life policy).

A qualifying policy issued on or before 21 March 2012 becomes a RRQP where, following a deceased beneficiary event on or after 6 April 2013, the new beneficiary is in breach of the premium limit.

 

3. Policies issued on or after 6 April 2013 – “New policies”

• a) Generally

Where a policy is issued after 5 April 2013 and has premiums of £3,600 or more in a 12 month period, or could exceed £3,600 as a result of options or terms within the policy, then the policy will be non-qualifying from outset.  This means that all chargeable event gains under the policy will be taxable.

This 12 month period begins on the date of the event e.g. the issue or variation of a policy as relevant. The £3,600 premium limit includes both premiums payable in that period on an individual’s qualifying policies as well as any additional premiums that could be payable as a result of options or terms in those policies.

Similarly, a policy will be non-qualifying from outset if it is effected after 5 April 2013 and, whilst the premiums under it don’t in isolation exceed £3,600 pa, they do when taking account of other earlier policies effected since 6 April 2013.  Such a policy will remain non-qualifying even if other earlier policies cease to exist because, say, they mature. 

If the total annual premiums payable under the combined policies exceed the £3,600 annual premium limit, the policy or policies whose premiums cause the limit to be breached will not be a qualifying policy.

Where the limit has been exceeded, a “last in, first out” approach applies so that the most recently issued policy or policies will not be a qualifying policy.  The position under cluster policies is described in 3(b) below. 

The annual premium limit applies to premiums payable throughout the life of a policy.  Therefore, where a policy starts off with a low premium but it is known that those premiums would exceed £3,600 in a later 12 month period then that policy will be non-qualifying from outset.

 

Example

• Bob

Bob has several qualifying policies that he effected before 21 March 2012. 

On 7 April 2017 he effects a new qualifying policy for a premium of £2,500 per annum. 

On the basis that Bob does not make any alterations to his existing qualifying policies, and the premiums under the new qualifying policy remain within the £3,600 per annum limit, then all gains under this new policy will be tax free.

It should be noted that had Bob’s new policy been for an annual premium of £4,500 per annum then, because premiums under this policy exceed £3,600 in a 12 month period, this policy would have been non-qualifying from outset so any gains under this new policy will be taxable as chargeable event gains .

 

• Bob (again)

Let’s take Bob’s circumstances again but this time instead of him effecting a qualifying policy for £2,500 per annum, after 5 April 2013 he effects:

• a policy for an annual premium of £3,000 on 7 April 2016 (Policy A); and
• a policy for an annual premium of £1,000 on 7 April 2017 (Policy B).

 

The impact of this is as follows:-

• Policy A is a qualifying policy because the premiums under it fall within the £3,600 limit and therefore all gains under this policy will be tax free;

• Policy B is not a qualifying policy because the premiums under it cause the £3,600 limit to be breached (after taking account of the premiums under Policy A). As a non-qualifying policy any gain will be taxable as a chargeable event gain.

 

• b) The significant modification rule outlined in 2 b) can apply.  
• c) The assignment rule outlined in 2 c) can apply. As the assigned policy was issued on or after 6 April 2013 it will become non-qualifying.
• d) The deceased beneficiary event outlined in 2 d) can apply.

As mentioned above, in the next article we will consider the position under “transitional policies” and calculation of restricted gains under restricted relief qualifying polices.

 

4. Cluster policies

Clearly, the identification rules outlined in 3) above could cause some confusion in the case of policies issued with identical segments as part of a master cluster policy.  HMRC accepts that these will be separate policies provided that the policies are genuinely distinct and self-contained and the documentation supports this.  In particular, each policy should be uniquely designated by appropriate sub-numbering.  It is also helpful if there are separate policy documents and separate schedules for each policy although this is not a condition for HMRC to accept that a policy is truly segmented. 

In cases where a cluster policy is issued and this causes the individual to exceed the £3,600 limit, the policy whose unique policy number is lower in either number or letter will be treated as issued first for the purposes of these new qualifying rules.  If a cluster has no identifying numbers and the annual premium limit is exceeded in respect of the policy as a whole, then the entire policy will be treated as a non-qualifying policy.