Simplification is the key - Centre for Policy Studies

Many savers are particularly bewildered by the tax treatment of life bonds, 51 which are
taxed very differently to pension funds. A life bond commingles long-term investment
with a single premium life assurance policy, and it is this latter feature that provides life
funds with their “non-qualifying” tax status. 52 This is in spite of the life assurance element
of the investment being very small (i.e. less than 1% of the amount invested).
Consequently, life funds pay tax but can deduct the expenses of writing new business
against capital gains, thereby reducing their effective tax rate on gains to less than 20%
(industry numbers range from 15% to 18%). Conversely, pension funds do not pay tax, and
therefore cannot offset their expenses.
HMRC treats life bond investors as if full basic rate tax has been paid, a benefit that
insurance companies are keen to point out via “technical notes” to investors when selling
investment bonds against other investment funds. But these notes never disclose the
rate of tax that the life fund could expect to pay in the future, because it varies,
depending on the financial position of the insurance company. This leaves the investor
(or his adviser) to guess the true extent of the benefit. More complexity to wrestle with.
Finally, tax relief adds to complexity because product design is often driven by the need
to maximise tax benefits rather than meet customer need. Why, for example, are life
insurance policies embedded into savings products which are regularly sold to trusts
designed to benefit children? The answer is related to tax and, historically, sales
commission (the latter will end once the Retail Distribution Review 53 has been
implemented).
2.4 Taking income in retirement: more complexity
Individuals retiring with appropriate pension rights can commute up to 25% of their
pension fund as a tax-free lump sum. Thereafter, but prior to reaching the age of 75,
retirement savings must either be used to purchase a lifetime annuity 54 or be taken as
unsecured income. 55
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Life bonds are also known as investment bonds which, confusingly, are nothing to do with the (fixed
income) bond market.
The Taxes Act 1988 specifies that single premium life assurance policies cannot be “qualifying” policies.
The underlying fund is therefore taxed on investment income and capital gains under the special rate of
corporate tax applicable to life assurance companies: 20%.
See Sections 4.7 and 4.8.
The May 2010 Coalition Agreement proposed the abandonment of compulsory annuitisation at 75.
Introduced in the Finance Act 2004 after the Plymouth Brethren objected on religious grounds to
compulsory annuitisation (which is against EU law).
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