What is payable when surrendering an investment policy?

Investment policies can offer a flexible way to invest and pass on wealth, but understanding the tax implications is often more complex than people expect. The tax treatment can vary depending on the type of policy, who owns it, whether it is held in trust, and when benefits are taken. In this article, we explore the key factors that determine how an investment bond is taxed, who may be liable for any tax due, and where planning opportunities may exist to help reduce potential tax liabilities.

How is tax calculated when cashing in an investment policy?

The answer to many tax questions is “it depends” and is particularly relevant when considering the tax implications on encashment of an investment policy. Before calculating any potential tax liability, several key questions need to be considered.

• Is the investment policy a qualifying policy?
• How much was paid into the policy and were the premiums regular or one-off?
• Is the policy held in trust?
• Who are the lives assured under the policy?
• Is there any outstanding loan repayable to the investors?
• Has a chargeable gain already been triggered?
• Is the investment held in an onshore or offshore bond?

Do you pay tax on withdrawals from an investment policy?

Many investment policies are written under life assurance rules and there are particular tax rules that are attributable to them. Often the investor can take regular annual withdrawals, and whilst this might supplement their income, it is not treated as income for tax purposes. It is a partial return of their capital investment. Notwithstanding this, if a gain is made on an investment policy, it is chargeable to income tax, typically at higher rates than capital gains tax.

Some policies are not subject to tax on surrender, but these tend to be the more traditional life assurance policies, rather than investment bonds, whereby the insured pays a regular premium and a payout is made on death or critical illness, for example. There is a limit to the size of the premiums payable for these to be exempt from tax on the gains.

For other investment bonds, the question of who owns the policy is important. It could be held by an individual investor, a beneficiary of a gift of the policy, or it could be held in trust.

When do you pay tax on gains from an investment policy?

A tax charge will be triggered by surrender, maturity or death of the last remaining life assured. The identity of the chargeable person will depend on who the policyholder is and, if it is held in trust, the timing of the death of the settlor in comparison to the date of the chargeable event, which could be the same time, or a different time if there are other lives assured.

The gain could be taxable on the settlor, the trustees or the beneficiaries, and the rate of tax and amount of reliefs available are determined by who it is that is chargeable. Where policies are held in trust, often some very simple planning can be undertaken before the death of the last life assured to make sure that it is the person with the lowest tax exposure that becomes charged on the liability.

Investment policies and inheritance tax

Investments written in trust often have inheritance tax advantages for the settlor, as the value may be removed from their taxable estate on death. However, a smaller inheritance tax charge might arise on assignment of a policy to a beneficiary, or on distributing cash proceeds following an encashment and it’s easy to overlook these charges in addition to any income tax on the gains.

By reviewing these investments prior to maturity, often very significant amounts of tax can be saved, depending on the size of the gains.

How much tax will I pay when cashing in an investment policy?

It depends but that doesn’t mean you have to figure it out alone. Our team can review your investment policy, explain the tax position and help ensure you’re making informed decisions before a chargeable event occurs