Is it time to cash in?
Getting your hands on a life insurance lump sum can be tempting but not always wise
Financial worries or just looking for better value for money? Consumer champion Fergus Muirhead can help
MY WIFE and I have life insurance policies and we are thinking of surrendering these.
They were taken out in 1978 and are “IB taxable whole life with profits” policies. The surrender value for each is approximately £12.5k, which is the same as the current death benefit.
Can you tell me if these policies are surrendered, would we be taxed and at what rate? And if they are subject to tax, would that deduction be made prior to payment or would it be deducted from our monthly income through PAYE?
Do you also know what amount the insurers are likely to take in any admin or other fees? Neil McKenzie (name changed by request) IT’S WORTH giving a bit of background to these polices before addressing your specific question. There are two ways you can set up a life assurance policy to pay out a lump sum of money, or indeed a regular income, when you die. The simplest way to do it is with a policy know as “term assurance”. With this type of insurance, the policy will pay out a set amount of money if you die while the policy is in force, usually for a specific period of time.
So if, for example, you have a mortgage for 20 years and you borrow £100,000, you might want a term assurance policy to last for 20 years and for the amount of cover to reduce as your mortgage reduces, assuming it is a repayment loan.
In this case, you would be looking at a decreasing term assurance policy. If your loan is set up on an interest-only basis, you will always owe the lender £200,000 and you would want to set up a level-term policy where the sum assured stays the same throughout the whole 20-year term.
If, on the other hand, you want a policy that will pay out whenever you die – be that in two weeks or 50 years – then you will need to look at a whole life policy.
These with profits policies were designed to pay a lump sum on the death of the policyholder, hence the “whole life” part of the name.
They had no initial term and could run as long as the policyholder was alive, paying out an amount that was equal to the initial sum assured on the policy as well as any bonuses attached to the policy on a year-by-year basis.
As well as that, the policy would often build up a “surrender value”, which means that in certain circumstances the policy could be
cashed in for a lump sum of money. If you cash the policy like this then you would, of course, lose the life assurance benefits that the policy was set up to provide.
These policies would typically be “qualifying policies” from the outset.
If the policy is “qualifying”, then policyholders do not have any further tax liabilities when a chargeable event – such as a surrender – occurs.
If you made changes during the lifetime of a policy – for example non-payment of premiums – this would make an IB Whole of Life policy non-qualifying. The surrender value would be paid to you without any deductions but the company would work out if a chargeable gain has occurred.
If that is the case, they would send you a chargeable gain certificate showing the resulting gain. Such gains are taxable as income, with basic rate tax deemed to have been paid on the gain. Further tax would then only be due from higher, or additional rate, taxpayers.
I’ve spoken to the insurance company concerned and they have confirmed there would be no tax liabilities on these policies.
The taxation of life assurance policies is an important consideration when deciding what type of policy is right for you.
Some life assurance policies are worth hundreds of thousands of pounds and you need to make sure you know how and when any benefit is going to be paid, who the benefit is going to be paid to and what the tax position of the benefit that is paid is likely to be.
It’s easy to buy life assurance online these days as it is very much driven by price so you need to make sure you have looked into the taxation side of things before deciding which type of policy is right for you.