CII R05 UK Tax Treatment of Protection Policies — Questions and Answers
Question 1: How is the lump sum payout from a personally held critical illness policy taxed in the UK?
- It is subject to income tax
- It is subject to capital gains tax
- It is paid free of income tax and capital gains tax (Correct answer)
- It is subject to inheritance tax if the policyholder dies within seven years
Correct answer: It is paid free of income tax and capital gains tax
Critical illness insurance pays a lump sum on diagnosis of a specified condition. When the policyholder themselves pays the premiums personally, the benefit is paid free of both income tax and capital gains tax.
Question 2: Under what circumstances are premiums paid on a personal income protection policy tax deductible?
- Always, as protection is a necessary personal expense
- When the policy is written in trust
- Never — personal income protection premiums are not tax deductible (Correct answer)
- Only if the policy has been in force for more than five years
Correct answer: Never — personal income protection premiums are not tax deductible
Premiums on personal income protection policies are paid from after-tax income and are not tax deductible for the individual. However, benefits are also paid free of income tax.
Question 3: How are benefits from a personally held income protection (permanent health insurance) policy taxed when paid to the policyholder?
- Benefits are taxable as earned income
- Benefits are paid free of income tax (Correct answer)
- Benefits are subject to National Insurance contributions
- Benefits are subject to a 20% flat rate tax
Correct answer: Benefits are paid free of income tax
Benefits from a personally held income protection policy are paid free of income tax, as the premiums were paid from post-tax income. This is the reciprocal tax treatment — no relief on premiums in, no tax on benefits out.
Question 4: An employer pays premiums on a group income protection policy for employees. How are these premiums treated for the employer?
- They are a disallowable expense for corporation tax
- They are treated as a P11D benefit in kind for employees
- They are a deductible business expense for the employer (Correct answer)
- They must be paid through the PAYE system
Correct answer: They are a deductible business expense for the employer
Employer premiums for group income protection (permanent health insurance) are a deductible business expense for corporation tax purposes, reducing the employer's taxable profit.
Question 5: Under a group income protection scheme where the employer is the policyholder, how are benefits paid to employees taxed?
- Benefits are paid free of all tax
- Benefits are paid to the employer and then paid as salary, subject to income tax and National Insurance (Correct answer)
- Benefits are paid directly to employees free of National Insurance but subject to income tax
- Benefits are taxed only if they exceed £30,000
Correct answer: Benefits are paid to the employer and then paid as salary, subject to income tax and National Insurance
Under employer-held group income protection, benefits are paid to the employer who then pays them to the employee as a continuation of salary. They are therefore subject to income tax and National Insurance contributions.
Question 6: A key person life assurance policy is taken out by a company on a key employee. In what circumstances would the premiums be deductible for corporation tax?
- Always, as a key person is essential to the business
- Never, as life assurance premiums are always disallowable
- When the policy is for pure protection (not investment), the benefit would be taxable in the company, and there is no element of permanent endowment (Correct answer)
- When the policy is written in trust for the employee's family
Correct answer: When the policy is for pure protection (not investment), the benefit would be taxable in the company, and there is no element of permanent endowment
HMRC allows corporation tax deduction on key person insurance premiums only if: the policy is short-term (term assurance), the benefit would be taxable as a trading receipt in the company, and it is not a whole of life or endowment type policy.
CII R05 UK Tax Treatment of Protection Policies
How is the lump sum payout from a personally held critical illness policy taxed in the UK?