Guidance

Check if a life insurance policy can be included in an investor's ISA

When you can include and remove life insurance policies from an investor's account if you're an ISA manager.

Qualifying investments

Insurance policies that satisfy the requirements in this guidance are a qualifying investment for a:

  • stocks and shares ISA
  • Lifetime ISA

Policies of life insurance

A policy of life insurance (as determined under general law) is eligible to be included in the ISA if the following conditions are satisfied:

  • the policy is on the life of the ISA investor
  • the policy’s terms and conditions state that:
    • the policy may be owned or held only as a qualifying investment for an ISA
    • the policy shall terminate automatically if it ceases to be owned or held in the ISA
    • the policy, or the rights conferred by the policy or any share or interest in the policy or rights respectively, other than the cash proceeds from termination or part surrender of the rights conferred, can’t be transferred to the investor
    • the policy, the rights conferred by the policy and any share or interest in the policy or rights respectively, are not capable of assignment or assignation (other than that the policy may be transferred from one ISA manager to another in accordance with the normal rules on ISA transfers), and the rights may vest in the personal representatives of a deceased investor (see death of an investor)
  • the policy evidences or secures a contract of insurance that either falls within paragraph I or III of Part II of Schedule 1 to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, or would fall within either of those paragraphs if the insurer was a company with permission under Part 4 of the Financial Services and Markets Act 2000 to effect or carry out contracts of insurance

The policy isn’t:

  • a contract to pay an annuity on human life
  • a personal portfolio bond within the meaning of section 516 of Income Tax (Trading and Other Income) Act 2005
  • a contract, the effecting and carrying out of which constitutes ‘pension business’ within the meaning of Section 58 to the Finance Act 2012

After the first payment in respect of a premium in relation to the policy has been made, there is no contractual obligation on any person to make any other such payment.

Rights under a linked long-term contract specified as a stakeholder product in Regulation 6 of the Stakeholder Product Regulations (FSMA 2000 (Stakeholder Product) Regulations 2004 (SI 2004/2738)) will qualify as an ISA insurance policy. Further information is available on the legislation.

Where an ISA policy fails any of the conditions the policy must be removed from the ISA (wrong sort of policy).

A policy of life insurance for the ISA must be on the life of the ISA investor alone. Joint life, multiple life and life of another policies aren’t permissible as a qualifying investment for the ISA. No special policy documentation is needed for ISA purposes other than that normally required under general law to evidence a contract between the policyholder and the insurer.

The ISA is ‘void’ and the policy should automatically terminate (policy in a void ISA) where:

  • the conditions relating to policy loans or connected policies have been fouled
  • any of the qualifying conditions including those applicable to the investor or the ISA manager are not satisfied, for example where an investor wasn’t eligible to subscribe to the ISA (who can subscribe to an ISA).

ISA managers may set a minimum limit for subscriptions, which if not reached would allow the insurer to terminate the policy (for example, a minimum limit of £500 premiums to be paid within 3 years).

ISA policies may give higher returns where:

  • a certain limit has been reached
  • further or regular subscriptions (premiums) are paid

An ISA policy may satisfy the requirement that it falls within paragraph I or III of Part II of Schedule 1 to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 if it includes subsidiary benefits such as a sickness, critical illness, accident or waiver of premium benefit. Payment of subsidiary benefits wouldn’t require a policy to terminate.

Subject to the connected policy rules, an ISA policy may incorporate an option to take out another policy, whether an ISA policy or a non-ISA policy, without the need for further medical evidence.

Where ISA subscriptions are applied as premiums under an ISA policy, and the subscriptions are payable in instalments, there must be no obligation to pay any instalment (or any premium) other than the first one. But this doesn’t prevent subscriptions being made by direct debit or standing order arrangements. Regular premium policies including ‘qualifying policies’ (Schedule 15 ICTA 1988 defines a ‘qualifying policy’) aren’t permissible investments.

The ISA may comprise a number of policies of life insurance. A cluster of policies may be issued in respect of a single subscription. Separate policies may be issued each year. This may have advantages if any invalid subscriptions are made and policies have to be terminated or if an investor wants to transfer part of the investment to a new ISA manager. The policies should be genuinely independent and free-standing.

The rights conferred by an ISA policy must be in the beneficial ownership of the investor. They can’t be put into trust.

Where a policy is surrendered or has paid benefits on maturity, ISA managers may use the proceeds to take out one or more new policies. Proceeds used in this way won’t count towards the subscription limit.

Connected parties

An ISA policy mustn’t be connected with any other policy or contract of insurance.

It’s connected with another policy or contract of insurance if either was made with reference to the other, or with a view to:

  • enabling the other to be made on particular terms
  • facilitating the making of the other on particular terms

and the terms on which the ISA policy was issued would have been significantly less favourable to the investor if the other insurance hadn’t been issued.

HM Revenue and Customs (HMRC) will accept that an ISA policy isn’t connected with another policy if:

  • a ‘feeder’ insurance is used to enable investors to fund future ISA policy premiums and the initial charges that would otherwise apply to the ISA policy are waived
  • an existing insurance is surrendered and an ISA policy is substituted and the initial charges that would otherwise apply to the ISA policy are waived

There is no requirement to apply discontinuation penalties or a market value adjustment.

The connected policy rule is aimed at preventing the avoidance of tax by, for example, shifting value from a taxable insurance policy or contract to an ISA policy. HMRC won’t use this provision in cases where the terms of the policies are the same.

For example - a valid ISA policy

An insurer may offer an ISA policy, on condition that the investor takes out a taxable policy of life insurance with a minimum premium of £10,000:

  • with an allocation rate of 100 plus x%
  • paying a bonus rate of y%
  • with an establishment charge of z%

Note - The rates and charges may vary depending, for example, on the total amount invested. For example, ‘x’ may be 1 for a total of £5,000, 2 for a total of £10,000, provided the same percentage applies to both policies. The rates or charges, where only the ISA policy is taken out, may be less (for example, an allocation rate of only 100%).

Loans

No sum may be lent at any time, at or after the making of the insurance, to or at the direction of the investor by or by arrangement with the body for the time being responsible for the obligations under the policy.

In practice, if a loan is made and it is formally secured upon a policy or contract that isn’t the ISA policy there is no requirement to terminate the ISA policy. But note the connected policy rules and the chargeable event rule.

An insurer can’t arrange a mortgage loan for an investor unless the loan is secured upon a policy or contract that is not the ISA policy. This wouldn’t prevent another company in the same group as the insurer granting a mortgage loan to the investor provided this wasn’t arranged by the insurer, but see the guidance about using an ISA as security for a loan.

Voiding and removing policies of life insurance in ISAs

A policy of life insurance is a qualifying investment for the stocks and shares ISA, the cash ISA, or the Lifetime ISA provided it meets the conditions for qualifying investments. The qualifying conditions must be written into the contractual terms of the policy.

Wrong sort of policy

A policy of life insurance which doesn’t satisfy the conditions for a qualifying investment - the wrong sort of policy – doesn’t qualify as an ISA investment and will automatically terminate. There is no provision under any circumstances for ‘repairing’ the policy and allowing it to continue.

Examples of the wrong sort of policy include, a policy:

  • on a life or lives other than that of the account investor
  • that doesn’t include in its contractual terms the terms and conditions regarding ownership and termination
  • that doesn’t constitute the right sort of insurance business or the right sort of policy

Insurers shouldn’t provide the wrong sort of policy as an ISA investment.

Policy in a void ISA

Where the policy meets the conditions for a qualifying investment but it is found that:

  • a subscription is invalid
  • the application to subscribe is incorrect
  • the policy is connected with another policy (connected policies)
  • the conditions relating to policy loans are fouled

the policy must terminate, unless it has already been surrendered, matured or paid out on death before the failure is discovered.

The policy will terminate in accordance with the contractual terms, on notice of the failure coming to the ISA manager.

The policy doesn’t terminate:

  • when the failure actually occurred, which may have been at inception or some time subsequently
  • on notice of the failure coming to the insurer (unless the insurer is also the ISA manager)

Where there is a failure, the policy is in a void ISA and must terminate. A policy that ended on surrender, maturity or death was in a void ISA if the qualifying conditions were fouled at any time during its existence.

Where the ISA manager isn’t the insurer, ISA managers must notify the insurer of the failure within 30 days of it coming to his notice. Notice may be given in writing or in some other way. Because the policy terminates when notice comes to the ISA manager, not when the insurer learns of the failure, which may be later, information should be passed on without delay. Otherwise the insurer may be exposed to an investment risk, for example, if the market were to crash between the date the policy terminates and the date the insurer is notified by the ISA manager.

Where an insurer is notified of, or identifies, a failure the information should be passed on to the ISA manager.

A policy in a void ISA remains part of the ISA business of the insurer throughout its existence. The condition that the policy must only be owned or held as a qualifying investment for an ISA is treated as being satisfied throughout the period from inception to either the notice of the failure coming to the ISA manager or the policy ending on surrender, maturity or death, as appropriate.

Chargeable events 

The special rules that tax gains on policies of life insurance, often known as the chargeable event rules, are used to recover tax reliefs that were not due on a policy in a void ISA. Tax liability may arise on the forced termination of the void policy and on any previous chargeable events that took place before the failure or before the ISA manager learns of the failure.

Where the ISA manager learns that a policy is held in a void ISA, the policy must terminate if it hasn’t already come to an end on death, surrender or maturity. In either case, what is called a ‘termination event’ arises. This is the earliest of:

  • the failure coming to the notice of the ISA manager
  • the coming to an end of the policy

A termination event arising as a result of a failure is deemed to be a chargeable event, namely the surrender of all the rights under the policy. The gain on a termination event must be calculated as if the policy was fully surrendered on the date of the termination event, that is when the failure came to the notice of the ISA manager, or the date on which the policy ended if that occurred earlier.

The exemption from tax on chargeable event gains on ISA policies doesn’t apply to gains on termination events or any excess events which have arisen as a result of part surrenders of the policy before the termination event. But the exemption remains for the actual full surrender (as opposed to the deemed full surrender on the termination event) or maturity of the policy, or the death of the investor.

An example of gain calculations on a policy in a void ISA is available.

Insurers must tell the investor about gains treated as arising by reason of a termination event and excess events that have occurred in connection with a policy in a void ISA. The insurer must send this information within 3 months of the insurer receiving notice of a failure, either in writing from the ISA manager or some other person, or in some other way. It may be necessary for the insurer to submit a number of certificates to a particular investor if there have been one or more excess events as well as a termination event.

The insurer must include the following information on each certificate which it sends to the investor:

  • policy or contract number
  • nature of event
  • date of event (which for termination events will be the date on which it occurred and for excess events the last day of the insurance year in which the relevant part surrender or part surrenders were made)
  • amount of the gain
  • number of years for top-slicing relief

The insurer doesn’t need to issue a certificate to the investor when no gain arises by reason of a chargeable event. If a corresponding deficiency arises as a result of the event, the insurer may also report the amount of the deficiency to the investor, if it wishes.

In order for the investor to complete his or her SA return, the investor will also need to know the amount of tax deducted (at the basic rate – 20% in 2014 to 2015) for each gain. The manager is required to report separately the amount of tax deducted – see Annual return and tax claims.

However, there is no objection to the insurer including on the certificate it sends to the investor the amount of tax deducted in relation to the gain being reported. This would mean that all the information the investor would need to complete the SA return would be set out in one document. But insurers should note that tax deducted is completely separate from ‘tax treated as paid’ which insurers report on gains from UK policies not held in ISAs and which mustn’t be reported on certificates for gains on policies in ISAs. Gains on policies in ISAs don’t attract tax treated as paid.

Exceptionally an insurer may also have to report a gain on a void policy to HMRC. The insurer is only required to report the gain to HMRC when the amount of the gain exceeds half the basic rate limit for the year of assessment in which the event took place (for example, gain more than £15,983 in 2015 to 2016).

Should the insurer be required to send a certificate to HMRC, it must include the required information plus the name and address of the investor. The insurer should send the certificate to HMRC using the appropriate contact details.

The time-limit for reporting a gain on a void policy to HMRC is the later of:

  • 3 months after the end of the tax year in which the event happened
  • 3 months from the date that the insurer first becomes aware of the termination event, either in writing or in some other way

No certificate is required where the gain is not more than half the basic rate limit for the tax year in which the event took place.

Insurers that aren’t also the ISA manager may wish to copy the information certificate to the ISA manager or provide the ISA manager with information about the gains in some other way. ISA managers should though be able to calculate gains from information in their own possession.

ISA managers must normally account for tax on any gains on a void policy at the basic rate in force for the year of assessment in which the chargeable event occurred. But HMRC will recover tax due directly from the investor where:

  • there are insufficient funds left in the ISA
  • an ISA has been closed before the ISA manager is aware that a recovery may be necessary

ISA managers must still provide details to investors – see the required information - within 30 days of it coming to the ISA manager’s notice.

ISA managers must keep a record of gains arising on void policies on a tax year basis.

Where appropriate, ISA managers should account for the tax by deducting the amount due from their next annual return and claim to HMRC.

Deficiency relief will be due to an investor if there are gains on excess events as a result of earlier part surrenders that exceed the overall gain on a policy in a void ISA. It’s a relief that may reduce an individual’s liability to tax at the higher rate. It’s not a relief from tax at the basic rate. Insurers are aware that large part surrenders may lead to this sort of result and may wish to bear it in mind in structuring their products and deciding what response they should make to a request for a large part surrender.

Example of gains calculations on a policy in a void ISA

Transactions

Policy taken out 10 September 2015 and held within an ISA.

Premiums of £1,000 paid into this policy on 10 September each year until 2018, that is, a total of £4,000.

Withdrawal of £500 through a part surrender on 3 March 2017.

It comes to notice of ISA manager (who is also the insurer) on 15 November 2018 that the ISA rules have been breached because investor has invested in a stocks and shares ISA with another provider earlier in the same tax year (say on 1 July 2008). The surrender value of the policy on 15 November 2018 is £6,000.

Under the terms of the policy, it is terminated soon after on 22 November 2018.

Consequences

The part surrender of £500 gives rise to an excess event on 9 September 2017 (the end of insurance year). The gain is £350 (£500-[5%x1000+5%x2000]). As the ISA is valid at that time, the ISA tax exemption still applies to this gain, although the subsequent voiding of the ISA will bring it into charge later.

A ‘termination event’ arises on 15 November 2018 (the day that the ISA manager receives notice of the failure). This is deemed to be a surrender chargeable event on that day and a chargeable event gain must be calculated as if the policy had been fully surrendered on that day.

The taxable gain on termination event is:

Event Amount
Surrender value on 15 Nov 2018 £6,000
plus earlier withdrawal of £500
  £6,500
less total premiums paid of £5,000
less gain on earlier excess event of £350
  £1,150

This event and gain, and the earlier excess event and gain of £350, which is now taxable, must be reported to the investor on chargeable event certificates by 14 February 2019 (3 months from the termination event).

The ISA manager must deduct tax at the basic rate of 20% from the gains on the termination event (£1150) and the excess event (£350), a total of £300, pay it to HMRC and report the amount to the investor.

There are no taxable consequences of the actual termination of the policy on 22 November 2018. Together, the taxable gains on the termination event and the excess event account for the tax on the gains on the policy.

Published 5 April 2018