HMRC is planning to reform rules which overlook the part surrender/part assignment of life insurance policies. It is hoped that the reform will address the ‘unfair’ tax bills which some people will face if they take money from an investment bond in the incorrect way.
The reforms would change how taxable income is calculated when money is taken from an investment bond. The consultation paper was published last week and in it, HMRC set out three potential changes to the rules to make sure that individuals will not receive tax bills which are disproportionate when they access their money early. Out of the three solutions, only one would be implemented. They are: taxing economic gain, deferring any gains which are excessive or introducing a 100% allowance which will replace the annual 5% tax free withdrawal which is currently in place.
One financial planning expert said that the simplest solution to the problem would be to introduce the 100% allowance. This is because the other two processes will require complicated calculations, impacting customers who wish to make a withdrawal from their policy. As some customers of life insurance policies already have difficulty understanding the current process, the two processes requiring complex calculations won’t solve the issue.
According to HMRC, opting to defer gains will mean keeping the current rules but leaving a benchmark, so that if a large sum is withdrawn, a safety net would appear to make sure that tax liability is set at an appropriate level. Taxing the economic gain would mean that some of the withdrawal would be treated as a premium rather than as taxable income. This means the tax liability would be in line with what the policy will actually make.
The proposals by HMRC have been anticipated by the life insurance industry. The financial expert said the industry hoped HMRC would give the power to insurers to rectify mistakes which occur in a small amount of cases, where tax liability has been extreme. It was such cases which had convinced HMRC to review the issue in the first place.
One of the main issues is that people who are hoping to make large withdrawals in the early stages of their policy, which is in excess of the 5% allowance, can find themselves having to pay income tax on the full amount that has been withdrawn. This has happened with 600 individual cases in the UK.
The consultation period for the tax free allowance reform review will end on the 13th July, 2016 and HMRC will make a decision.
For more about income tax, call the tax helpline.