Chris O'Neill looks at the tax consequences of assignments of life policies and the tax planning opportunities the rules offer
An assignment is a transfer of legal ownership from one party to another. Common types of assignment include assignments by way of gift, assignments by way of mortgage and assignments into (or out of) trust. Here we look at the tax consequences of assignments of life policies and the tax planning opportunities that the rules offer.
For non-qualifying policies, such as investment bonds, a full assignment is only a chargeable event for income tax purposes if it is for money or money's worth. Furthermore, assignments by way of mortgage and assignments between spouses living together are never chargeable events.
The same rules apply to qualifying policies except that the assignment for money or its worth can only be a chargeable event if it occurs within ten years, or three-quarters of the term if sooner, or the policy has been made paid-up during the same time span.
The most common situations where a life policy is assigned for consideration are as part of a divorce settlement and traded endowment policies.
In the case of the latter, the amount of consideration to be used in any chargeable gain calculation will be obvious. In the event of divorce, the amount of consideration is less clear-cut but would normally be the surrender value of the policy at the time of assignment. The chargeable gain is calculated as for a final surrender with the person assessable being the assignor.
If an assignment is for money or money's worth, capital gains tax may also come into play. Life policies are normally exempt from CGT: exceptions occur where someone other than the original beneficial owner disposes of the policy and that person has acquired the policy for money or its worth. If an individual buys a second-hand endowment for example, then a CGT liability may arise on its disposal. There could be both a chargeable event for income tax and a gain for CGT.
In this event, the former takes precedence and any amount potentially chargeable to income tax, the chargeable gain, is deducted from the disposal proceeds for CGT to avoid double taxation.
The CGT liability (if any) in the above example could be avoided if the purchaser subsequently assigns the policy by way of gift, such as to a spouse. Someone who has not acquired the policy for money or money's worth would then make the disposal and the life policy recovers its CGT exemption.
Assignments of life policies into and out of trust would normally be purely by way of gift and so would not create any income or capital gains tax problems.
Part assignments have been the cause of much debate and disagreement between the life industry and the Inland Revenue. This has resulted in new legislation in Finance Act 2001 that has changed the rules and, hopefully, clarified the taxation of part assignments.
First, what is a part assignment? A part assignment, also sometimes known as an assignment of a share, is where only part of the policy rights is transferred from one party to another. This would apply where there is shared ownership before and/or after the transfer with at least one common owner.
The following are examples of part assignments: A transfers to A and B; A and B transfer to B; or A and B transfer to A and B and C. The following are not part assignments but rather full assignments as dealt with above: A transfers to B; A transfers to B and C; or A and B transfer to C. The difference is that with a part assignment, there is at least one common owner before and after the transfer.
A part assignment is taxed in a similar way to a part surrender, by calculating a 'part surrender gain' with reference to the 5% annual allowance. Prior to the recent change in the legislation, part assignments would be chargeable events whether or not money or money's worth was involved, although there was (and still is) an exemption for transfers between a husband and wife living together. Thus, transfers of the type A and B to A were chargeable events, even if by way of gift, unless between married couples not living apart.
The legislation has changed so that, for policy years beginning on or after 6 April 2001, part assignments made by way of gift will no longer be chargeable events. On part assignments made for consideration (as part of a settlement between divorcing couples, for example), where a tax liability can still arise, it will now ' more logically ' be the person who gives up the interest (the assignor) who will be liable for the gain arising.
Previously, the legislation stated that it would have been the assignee that was taxable. As with a part surrender, the chargeable event occurs at the end of the policy year rather than at the time of the assignment. Assignments of life policies are frequently used as part of a tax planning exercise either to reduce or eliminate higher rate income tax liability on surrender or to create a lifetime transfer for inheritance tax purposes.
Assigning a policy is a common ploy for avoiding a higher rate tax charge. Consider the situation where a higher rate taxpayer owns an investment bond. If the bond is encashed, there will be an 18% income tax liability on any chargeable gain. However, what if the policyholder has a non-higher rate taxpaying spouse? Assignment of the policy by way of gift to the spouse (or anyone else) will not be a chargeable event and ensures that future gains are assessed on the assignee.
Top-slicing relief will be based on the term of the policy ignoring the assignment, so it should be possible to avoid, or certainly minimise, any higher rate liability. It is important that the assignment is genuine and that benefits do not flow back to the assignor. For example, if a policy is assigned to the spouse who subsequently surrenders it, it would be risky for payment to be made to a joint account. If this happened, the Inland Revenue might argue that the assignor still had a joint beneficial entitlement and seek to tax the proceeds accordingly. It may also be prudent to leave a reasonable time gap between the assignment and any subsequent transaction, such as surrender, in order to minimise the risk of any anti-avoidance challenge from the Revenue.
For elderly policyholders, an assignment may also be a useful strategy for protecting age allowance. The one difference is that top-slicing relief is not available for age allowance purposes.
Trustees may also consider assigning policies prior to encashment in order to achieve a more favourable tax rate. If a life policy is subject to trust, then any chargeable gains will normally be assessed on the settlor, namely the creator of the trust.
If the settlor is a higher rate taxpayer, then the gains will be taxed at 18%. However, if the settlor died in an earlier tax year then it will normally be the trustees that are taxable. If this is the case, the trust tax rate of 34% will apply although for onshore policies, a basic rate tax credit at 22% will be available. Thus, the trustees will pay tax at 12% on any life policy gains and they do not get the benefit of top-slicing relief.
If the settlor is alive and a higher rate taxpayer, it may be advantageous to assign policies to beneficiaries. If the beneficiaries subsequently surrender policies, then it is their tax rates that are relevant and they will get the benefit of top-slicing relief for the entire term of the policies. Obviously, the beneficiaries surrendering policies rather than the trustees would only make sense if their tax rates are more favourable than the settlor's.
Similarly, if the settlor is dead, the best tax result will depend on whether the beneficiaries' tax rates are less than the trust rate of 34%. If the beneficiaries are higher rate taxpayers then it would be better to leave things as they are and for the trustees to incur a 12% tax charge on any chargeable gains.
In any event, assignment would only be possible if the relevant beneficiary is adult and the terms of the trust allow such a course of action. It should also be considered that if the trust is for the absolute benefit of an adult beneficiary, as with a bare trust, then it is the beneficiary that is assessable, regardless of whether the settlor is alive or not. This means there is no possibility of the gain being assessed on either the settlor or the trust. Of course, an adult beneficiary with an absolute interest could assign that interest to a third party.
Assignments of life policies are also commonly used as a part of an inheritance tax planning (IHT) exercise.
Assigning a life policy will be a lifetime transfer for IHT purposes. The transfer will be a potentially exempt transfer (PET) to the extent that any available exemptions are exceeded unless the assignment is to a discretionary trust, in which case it will be a chargeable transfer. The most likely exemptions are the spouse exemption and the annual gift exemption. Providing the spouse is UK domiciled, then the entire transfer will be exempt. All individuals have an annual gift exemption of £3,000. If this is unused it can be carried forward for one year before being lost. Gifts of up to £6,000 (£12,000 for a couple) may therefore be immediately exempt from IHT.
Gifting a life policy into trust will ensure that the proceeds fall outside the donor's estate and are not liable to IHT, providing the donor cannot benefit under the trust. The value of the transfer (normally the surrender value of the policy at the time) will be either an exempt, potentially exempt or chargeable transfer or a combination of these as explained above. If the donor survives the gift by seven years, there will be no inheritance tax to pay on death.
• An assignment is a transfer of legal ownership from one party to another.
• Common examples include assignment by way of gift, mortgage, or into, or out of, trust.
• The main difference between full and part assignments is that with a part assignment there is at least one common owner before and after the transfer.
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