CII R05 Taxation of Protection Products — Questions and Answers
Question 1: How are the proceeds of a qualifying life assurance policy taxed when paid as a death benefit to the policyholder's estate?
- The proceeds are subject to income tax at the policyholder's marginal rate
- The proceeds are generally free of income tax and capital gains tax, though they may be subject to inheritance tax if not written in trust (Correct answer)
- The proceeds are subject to 40% capital gains tax
- The proceeds are always completely tax-free regardless of whether the policy is in trust
Correct answer: The proceeds are generally free of income tax and capital gains tax, though they may be subject to inheritance tax if not written in trust
Qualifying life policy proceeds are generally free of income tax and capital gains tax. However, if the proceeds form part of the deceased's estate, they may be subject to inheritance tax at 40% on the value above the nil-rate band. Writing the policy in trust removes the proceeds from the estate and avoids IHT.
Question 2: Income protection benefit payments received by an individual policyholder are treated for tax purposes as:
- Tax-free capital payments
- Earned income subject to income tax and National Insurance contributions
- Taxable income subject to income tax under PAYE but not National Insurance contributions (Correct answer)
- Tax-free if the deferred period is longer than 26 weeks
Correct answer: Taxable income subject to income tax under PAYE but not National Insurance contributions
Individual income protection benefits paid under a personally-owned policy are subject to income tax under PAYE but are NOT subject to National Insurance contributions. This is because the benefit is treated as income replacement rather than earnings from employment. The premiums for individual policies are not tax-deductible.
Question 3: Are premiums paid for an individual term assurance policy tax-deductible for the policyholder?
- Yes, they are fully deductible against income tax
- No, premiums for individual protection policies are generally paid from taxed income with no tax relief (Correct answer)
- Yes, but only if the policyholder is a higher-rate taxpayer
- Yes, they qualify for relief at 20% under the life assurance premium relief scheme
Correct answer: No, premiums for individual protection policies are generally paid from taxed income with no tax relief
Premiums for individual protection policies (term assurance, critical illness, income protection) are paid from taxed income and do not qualify for income tax relief. Life Assurance Premium Relief (LAPR) was abolished for new policies from 14 March 1984, so only policies taken out before that date may still benefit from this relief.
Question 4: An employer pays the premiums for a group life assurance scheme (death in service). How are the premiums treated for tax purposes?
- The premiums are a taxable benefit in kind for the employee
- The premiums are an allowable business expense for the employer and are not treated as a benefit in kind for the employee (subject to HMRC approval) (Correct answer)
- The premiums must be paid from the employee's net salary
- The premiums attract capital gains tax for the employer
Correct answer: The premiums are an allowable business expense for the employer and are not treated as a benefit in kind for the employee (subject to HMRC approval)
Premiums paid by the employer for a registered group life assurance scheme are an allowable deduction against corporation tax as a business expense. Provided the scheme is set up under an excepted group life policy or registered arrangement, the premiums are not treated as a benefit in kind for the employee and do not generate an income tax charge on the employee.
Question 5: Critical illness benefit payments received under a personal policy are generally treated as:
- Taxable income at the policyholder's marginal rate
- Tax-free lump sum payments, as they are treated as capital sums from a qualifying policy (Correct answer)
- Subject to capital gains tax at 20%
- Taxable at a flat rate of 10%
Correct answer: Tax-free lump sum payments, as they are treated as capital sums from a qualifying policy
Critical illness benefit payments under a personal policy are generally tax-free lump sums. They are treated as capital payments from a qualifying (or non-qualifying but still exempt) life policy. The payment is made on the occurrence of a specified event (diagnosis of a critical illness) and is not subject to income tax or capital gains tax.
Question 6: How is a relevant life policy taxed in relation to the employer's premium payments and the benefit paid on death?
- Premiums are not tax-deductible and the benefit is subject to inheritance tax
- Premiums are an allowable business expense for the employer, not a benefit in kind for the employee, and the death benefit is paid free of inheritance tax via a discretionary trust (Correct answer)
- Premiums attract VAT and the benefit is subject to income tax
- Premiums are paid by the employee from net salary and the benefit is tax-free
Correct answer: Premiums are an allowable business expense for the employer, not a benefit in kind for the employee, and the death benefit is paid free of inheritance tax via a discretionary trust
A relevant life policy offers triple tax efficiency: the employer's premiums are deductible as a business expense against corporation tax, the premiums are not treated as a benefit in kind for the employee (so no income tax or NIC charge), and the death benefit is paid via a discretionary trust outside the employee's estate, free of inheritance tax.
CII R05 Taxation of Protection Products
How are the proceeds of a qualifying life assurance policy taxed when paid as a death benefit to the policyholder's estate?