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Inside this Article
Tax
And Life Insurance
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Taxation
of life insurance in the United States
Premiums paid by the policy owner are normally not deductible
for federal and state income tax purposes.
Proceeds paid by the insurer upon death of the insured are not
includible in taxable income for federal and state income tax
purposes;
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however, if the proceeds are included in the
"estate" of the deceased, it is likely they will be
subject to federal and state estate and inheritance tax. Cash
value increases within the policy are not subject to income taxes
unless certain events occur. For this reason, insurance
policies can be a legal and legitimate tax shelter wherein.
savings can increase without taxation until the owner withdraws the
money from the policy.
On flexible-premium policies, large deposits of
premium could cause the contract to be considered a "Modified
Endowment Contract" by the IRS, which negates many of the tax
advantages associated with life insurance. The insurance
company, in most cases, will inform the policyowner of this danger
before applying their premium.
Tax deferred benefit from a life insurance policy may be
offset by its low return or high cost in some cases. This depends upon
the insuring company, type of policy and other variables (mortality,
market return, etc.). Also, other income tax saving vehicles (i.e. IRA,
401K or Roth IRA) appear to be better alternatives for value
accumulation, at least for more sophisticated investors who can keep
track of multiple financial vehicles. The combination of low-cost term life
insurance and higher return tax-efficient retirement accounts can
achieve better performance, assuming that the insurance itself is
only needed for a limited amount of time.
The tax ramifications of life insurance are complex. The
policy owner would be well advised to carefully consider them. As
always, Congress or the state legislatures can change the tax laws at
any time.
Taxation
of life assurance in the United Kingdom
Premiums are not usually allowable against income tax or corporation
tax, however qualifying policies issued prior to 14 March 1984 do still
attract LAPR (Life Assurance Premium Relief) at 15% (with the net
premium being collected from the policyholder).
Non-investment life policies do not normally attract either income
tax or capital gains tax on claim. If the policy has as investment
element such as an endowment policy, whole of life policy or an
investment bond then the tax treatment is determined by the qualifying
status of the policy.
Qualifying status is determined at the outset of the policy if the
contract meets certain criteria. Essentially, long term contracts (10
years plus) tend to be qualifying policies and the proceeds are free
from income tax and capital gains tax. Single premium contracts and
those run for a short term are subject to income tax depending upon your
marginal rate in the year you make a gain. All (UK) insurers pay a
special rate of corporation tax on the profits form their life book;
this is deemed as meeting the lower rate (20% in 2005-06) liability for
policyholders. Therefore if you are a higher rate taxpayer (40% in
2005-06), or become one through the transaction, you must pay tax on the
gain at the difference between the higher and the lower rate. This gain
may be reduced by applying a complicated calculation called top-slicing
based on the number of years you have held the policy.
Although this is complicated, the taxation of life assurance based
investment contracts may be beneficial compared to alternative equity
based collective investment schemes (unit trusts, investment trusts and
OEICs). One feature which especially favours investment bonds is the
ability to draw 5% of the original investment amount each policy year
without being subject to any taxation on the amount withdrawn. The
withdrawal is deemed by HMRC (Her Majesty's Revenue and Customs) to be a
payment of capital and therefore the tax calculation is deferred until
further encashment above the 5% limit. This is an especially useful tax
planning tool for higher rate taxpayers who expect to become basic rate
taxpayers at some predictable point in the future (e.g. retirement).
The proceeds of a life policy will be included in the estate for
inheritance tax (IHT) purposes. Policies written in trust may fall
outside the estate for IHT purposes but it's not always that simple. If
in doubt you should seek profession advice from an IFA (Independent
Financial Adviser) who is regisetered with the government regulator: the
Financial Services Authority.
Pension
Term Assurance
Although available before April 2006, from this date pension term
assurance became widely available in the UK, only to then largely be
withdrawn in December 2006. Pension term assurance is effectively term
life assurance with tax relief on the premiums. All premiums are paid
net of basic rate tax at 22%, and higher rate tax payers can gain an
extra 18% tax relief via their tax return. Although not suitable for
all, PTA briefly became one of the most common forms of life assurance
sold in the UK, before tax law changed in December 2006 to take away the
tax advantages.
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