Rachael Griffin: How to maximise life policy surrenders


Last month’s Autumn Statement confirmed that, from 6 April, HM Revenue & Customs will be allowed to correct the unequal tax positions that can occur when people withdraw money from their life policies.

The issue came under the microscope in March 2015, when Joost Lobler won a court case against HMRC.

Lobler undertook two large part surrenders generating a tax bill of $560,000, which exhausted his life savings and could have bankrupted him, even though the life assurance policy had made no substantial profit.

In light of the case, the Government chose to take steps to rectify the situation, putting the safety net confirmed at the Autumn Statement in place. However, this safety net is not something people should rely on. Indeed, it appears the process is by application to HMRC, which suggests it has discretion on whether or not to accept.

Guidance will be key to helping advisers understand the calculation basis HMRC is proposing and when they can apply. However, surely it is better to avoid the scenario altogether and think about how to keep tax liability low?

The issue of the Lobler case is one of taxation. As a UK tax resident, a client is subject to UK taxation, including any income tax liability as a result of a chargeable event.

For the most part, it is more tax-efficient to withdraw money (over and above the annual 5 per cent allowance) through surrendering individual policy segments, rather than through a partial surrender across all policies. That said, individual client circumstances obviously need to be taken into account.

Take, for instance, an additional rate taxpayer that invests £1m in an onshore bond in 2012. The client now wants to withdraw £500,000 to help their child start a business. The way they choose to do this will create two very different tax scenarios.

Partial surrender

The bond has 100 different segments and is now worth £1.2m. Since the client has owned the bond for three years, they can take out up to £200,000 without incurring an immediate liability to income tax.

This is 5 per cent of the original investment rolled up over four years. Any additional amount is chargeable to income tax.

So the £500,000 taken from the bond will result in a chargeable gain of £300,000 at 45 per cent because the client is an additional rate taxpayer.

As the investment is onshore, 20 per cent tax is deemed as already paid, so the £300,000 gain will be charged a further 25 per cent, giving the client a tax bill of £75,000.

The partial surrender option would be more beneficial if the bond had been invested for longer, allowing tax deferral privileges to accumulate for a longer period of time.

Full surrender

The alternative option is a full surrender of individual policies to make up the required £500,000.

The bond’s 100 segments are each worth £12,000, so the client would need to surrender 42 policies (42 x £12,000 = £500,000). The chargeable gain on the
full surrender policy is £12,000 minus the original investment of £10,000; therefore £2,000 per policy.

So surrendering the 42 policies gives a gain of £84,000, taxable at 25 per cent – or tax liability of £21,000. By surrendering individual policy segments instead of partial surrender the client saves £54,000 in tax.

Rachael Griffin is financial planning expert at Old Mutual Wealth