Endowment Tax Issues Explained

When an investor disposes of a TEP whether this occurs as a result of a death claim, the policy maturing or the investor deciding to surrender or re-sell the policy via the TEP market, tax becomes payable.

The tax position at the maturity of a traded endowment policy, for those resident in the United Kingdom for tax purposes, will depend on whether the policy is qualifying or non qualifying.

Under the Income and Corporation Taxes Acts, the specifics of the policy determine whether it is approved as a 'qualifying' policy by the Inland Revenue.

qualifying policies

These policies are not subject to Income Tax but under the Taxation of Chargeable Gains Act 1992 the receipt of benefit by the investor in the event of death, maturity, surrender or subsequent sale will give rise to a disposal for Capital Gains Tax purposes. In other words, Capital Gains Tax will be due should the proceeds at maturity, after deducting the purchase price, premiums and tapering relief, exceed the tax free allowance.

The following is an example of how the Capital Gain is calculated:

Details of the Policy:

Assumed Inflation 3% per annum (Assumed annual inflation)

Capital Gain Calculation:

The investor of this policy would be seen to have a taxable gain of £7,454. This gain is taxable at the marginal rate applicable to the investor. If the investor had not already used any of his/her Capital Gains Tax Allowance (£7,200 in 2001) they would be liable to pay tax on £254.

Such issues are best discussed with a tax adviser.

non qualifying policies

higher rate tax payers

The profit (chargeable event) is subject to Income Tax at the marginal rate, which is the difference between higher and basic rate tax (40%-22%=18%) as at April 2001. Tax is applicable to the maturity figure less all premiums paid since inception of the policy.

basic rate tax payers

The proceeds will be tax-free to basic rate tax payers. Marginally higher rate tax payers will probably have to pay some tax, but will benefit from a complex mitigation opportunity known as "top slicing".