IHTM20371 - Life Policies: life policy linked with an annuity: introduction and background
There are special statutory provisions dealing with life policies linked with annuities because this situation can be used to avoid Inheritance Tax.
What happens in the typical case is that someone in poor health buys an annuity for their own benefit for a lump sum payment. At the same time they buy a life policy on their own life but for the benefit of someone else. The annuity payments are used to pay the premiums on the life policy. The idea is to make the transfer to the beneficiary non-taxable by making use of the normal expenditure out of income exemption (IHTM14231) under IHTA84/S21.
However, someone in poor health would not normally be able to take out life assurance at normal premium rates because there would be a financial disadvantage to the insurance company. The only way the company would agree to write a life policy whose sum assured (IHTM20086) was substantially more than the premiums paid was if it derived an even greater benefit from an associated transaction, in this case the annuity taken out in conjunction with it. With the linked annuity, the health or life expectancy of the life assured (IHTM20081) would not matter to the company because it would benefit from either the annuity or life policy depending on how long the policyholder lived.
So without special statutory provisions (IHTM20374) a tax-free transfer of capital would take place by using an exemption designed for the transfer of income.
Linked annuity and life policies are also known as ‘back-to-back policies’ (IHTM20087)