Life insurance policies ― deficiency relief

Introduction

The profits from the surrender of certain life insurance policies are treated as savings income (rather than capital gains), even though these profits are known as chargeable event gains. These chargeable event gains are taxed last after all other income in the income tax computation. Usually the chargeable event gain has a 20% deemed tax credit attached, which means that if the policy-holder is a basic rate taxpayer they will not have any further tax to pay. See the Life insurance policies and Life insurance policies ― top slicing relief guidance notes. It is recommended that you read these guidance notes first as the commentary below assumes familiarity with concepts discussed in those guidance notes.

However, what a loss arises on the surrender of the policy instead of a gain? A loss arises where the individual receives less than the premiums paid over the lifetime of the policy or the gain on surrender is less than the chargeable event gains which were previously taxed. In this situation, the individual may be able to benefit from deficiency relief. This guidance note discusses when deficiency relief is available, how to calculate the deficiency and how to calculate the tax relief.

Note that different rules may apply to foreign policies and these are covered in the Offshore bonds and other foreign policies guidance note. That guidance note also explains how to find out if your client has a foreign policy.

Conditions for deficiency relief

Deficiency relief is only available if:

1. •

   the chargeable event arises on the termination of the individual’s interest in the policy (ie on death, maturity, full surrender or taking a capital sum as an alternative to annuity payments)

2. •

   one or more gains arose in previous tax years on a chargeable event which was not a ‘personal portfolio bond event’ (ie a chargeable event gain has arisen in the past in relation to the policy. In the case of gains arising on a part