Individual Savings Accounts (ISAs) for managers: life insurance policies
Guidance about qualifying life insurance policies for ISA managers.
Life insurance policies in ISAs
A life insurance policy will qualify as an ISA insurance policy if it satisfies the rules set out in the Financial Services and Markets Act 2000. Also, an ISA policy may satisfy the requirement if it includes subsidiary benefits such as a sickness, critical illness, accident or waiver of premium benefit. Payment of subsidiary benefits would not require a policy to terminate.
The policy must be on the life of the ISA investor alone - joint life, multiple life and life of another policy are not permissible as a qualifying investment.
Subscriptions and returns
ISA policies may give higher returns where a certain limit has been reached, or further or regular subscriptions (premiums) are paid. You can 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).
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 does not prevent subscriptions being made by direct debit or standing order. Regular premium policies including qualifying policies are not 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.
If a policy is surrendered or has paid benefits on maturity, you may use the proceeds to take out one or more new policies, however, proceeds used in this way will not count towards the subscription limit.
Connected policy rules
An ISA policy must not be connected with any other policy or contract of insurance. 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. HM Revenue and Customs (HMRC) will not use this provision in cases where the terms of the policies are the same.
An ISA policy is 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
- the terms on which the ISA policy was issued would have been significantly less favourable to the investor if the other insurance had not been issued
HMRC will accept that an ISA policy is not 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’s no requirement to apply discontinuation penalties or a Market Value Adjustment.
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 freestanding.
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, you may use the proceeds to take out one or more new policies. Proceeds used in this way will not count towards the subscription limit.
An insurer can’t arrange a mortgage loan for an investor unless the loan is secured on a policy or contract that is not the ISA policy. This would not prevent another company in the same group as the insurer granting a mortgage loan to the investor so long as it isn’t arranged by the insurer.
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 on a policy or contract that is not the ISA policy there’s no requirement to terminate the ISA policy.
Voiding and removing policies of life insurance in ISAs
A life insurance policy is a qualifying investment for either a Stocks and Shares ISA or a Cash ISA provided it meets the qualifying conditions which must be written into the contractual terms of the policy.
Policy in a void ISA
Unless the qualifying policy has already been surrendered, matured or paid out on death, it must be terminated if it is found that the:
- subscription is invalid
- application to subscribe is incorrect
- policy is connected with another policy
- conditions relating to policy loans are fouled
The policy will terminate in accordance with the contractual terms, once you notice there has been a failure.
The policy does not 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 you)
Where there is a failure, the policy is in a void ISA and must terminate. A policy that ended on surrender, maturity or death is in a void ISA if the qualifying conditions were fouled at any time during its existence.
If you’re not the insurer, you must notify the insurer of the failure within 30 days of it coming to his notice. Because the policy terminates when notice comes to you, 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 you.
Where an insurer is notified of, or identifies, a failure the information should be passed on to you.
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 you or the policy ending on surrender, maturity or death, as appropriate.
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 you learn of the failure. Where you learn that a policy is held in a void ISA, the policy must terminate if it has not 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 your notice
- coming to the 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 your notice, 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.
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 you 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.
You’re required to report the amount of tax deducted (at the basic rate) in respect of each gain separately, you can include the amount of tax deducted in relation to the gain so that the investor can complete their Self Assessment Tax return.
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 must not 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.
If the insurer needs to send a certificate to HMRC, it must include on the certificate the information set out above plus the name and address of the investor.
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
- from the date that the insurer first becomes aware of the termination event, either in writing or in some other way
A certificate isn’t required where the gain is not more than half the basic rate limit for the tax year in which the event took place.
Insurers may wish to copy the information certificate to you or provide you with information about the gains in some other way. You should be able to calculate gains from information in their own possession.
You 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 you’re aware that a recovery may be necessary
You must still provide details to investors within 30 days of it coming to your notice and keep a record of gains arising on void policies on a tax year basis.
Where appropriate, you should account for the tax by deducting the amount due from their next 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 is a relief that may reduce an individual’s liability to tax at the higher rate. It is 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.