Life insurance policies

Types of policy

Insurance policies are either qualifying or non-qualifying.

Qualifying

Qualifying policies are generally long-term policies where regular sums are paid in. There is typically no tax when a qualifying policy matures.

Non-qualifying

Non-qualifying policies tend to be policies which are funded by a single premium rather than regular contributions. They are much more likely to give rise to tax consequences when they mature. We explain how to work out if tax on non-qualifying policies is due below.

Tax on profits (gains)

If you take out an insurance policy or investment bond, the profits (often called 'gains') you make on the policy or investment bond when you cash it in might be taxable. You should ask a financial adviser or a specialist tax adviser for more information.

This guidance covers those policies where the profits are taxable.

Regular income

Each year you can withdraw, tax free, up to 5% of the amount you originally invested. If you do not withdraw 5% in one year you can carry it forward. For example, if you have previously taken nothing out of the policy, in year three you could take 15% (3 x 5%).

Any amounts you withdraw as an income will be taken into account when you cash in the policy and will make the final profit higher, so it is worth remembering this if you do not need to take out the money each year.

Part surrender

If you take more than 5% out (or the percentage you are allowed to take out, if you have 5% amounts brought forward from earlier years), you may trigger a taxable gain on the excess – even if the policy has not made a gain on its original investment or has made a loss.

If the gain triggered appears to be very excessive compared to the value of the investment and the amount cashed in, you should ask HMRC to recalculate the gain on a ‘just and reasonable’ basis. For further information, see Part 4 of HMRC’s Helpsheet 320 Gains on life insurance policies. For details of how to make the application, see this part of HMRC’s insurance policyholder taxation manual.

Full surrender (cashing in)

You make a profit or gain on the policy if the amount you get when you cash it in is more than the amount of the premiums you have paid.

When you cash in the policy, any profit you make is free of capital gains tax. You can think of it instead as an 'income tax gain'. This is not the same type of gain that you make when you sell or give away an asset.

If you pay tax at the starting rate for savings, savings nil rate (personal savings allowance) or are a 20% basic rate taxpayer, you have no more tax to pay on the profit or gain you make. This is because the profit that you make on the policy is treated as having already suffered tax at 20%. Offshore bonds do not carry the 20% ‘credit’.

Please note that it is not possible to get any of this tax back. This is because the 20% deduction does not equate to a ‘withholding tax’ as such. Rather, the arrangements reflect the unique regime applying to life insurance companies, under which part of the corporation tax paid is regarded as relating to investment gains made in the company for the benefit of policyholders. The personal savings allowance does, however, apply to other types of savings income before life insurance gains. This minimises situations in which no repayment is available in respect of non-taxable gains treated as taxed at the basic rate.

If you are a higher rate (40% in 2024/25) or additional rate (45% in 2024/25) taxpayer, you will have to pay extra tax. The profit on the policy is treated as the very top slice of your income. If you are a higher rate taxpayer, you will pay tax at 40% less the 20% tax that you are treated as having already paid.

Top-slicing relief

If the profit pushes a basic rate taxpayer into higher rate or a higher rate taxpayer into the additional rate, there is a special relief available, called ‘top slicing relief’.

Top slicing relief may assist in reducing the amount of tax charged by applying a spreading mechanism. This recognises the fact that although the gains have probably arisen over the period of investment, they are assessed in a single year which can cause a disproportionately higher liability.

Consider, for example, someone who invested £10,000 in a bond and left it for 10 years, during which time it doubled in value. If the entire profit of £10,000 was assessed in a single year, it might attract a higher amount of tax than if the returns were assessed annually. With top slicing relief applied, the gain of £10,000 would be divided by the number of complete years the bond had been held, in this case 10, creating an average gain of £1,000. The top sliced gain is added to the investor’s taxable income in the year the bond is cashed in and the amount of tax due on the top sliced gain is calculated. This is then multiplied by the number of years the bond was held to find the tax due on the total gain. So, top slicing relief has the effect of calculating any tax that may be payable at the investor’s marginal rate of tax on the average annual gain.

HMRC’s Helpsheet 320 explains this further. However, the calculations can be complex, so you should consider checking your position – for example, by contacting HMRC or seeking professional advice if you think this is likely to apply to you.

You need to show the profits on your tax return if you need to complete one and you will receive details of the amount to be included from your insurance company. This is called a chargeable event gain certificate. If you do not receive a certificate, you should contact the company and ask for one.

You should bear in mind that any life insurance profits count as your income when working out what married couple's allowance you may be entitled to, or whether you are entitled to the marriage allowance. Even though you may still be a basic-rate taxpayer, the loss of married couple's allowance means you will effectively be paying more tax.

You can read more about top slicing relief in HMRC’s technical Insurance Policyholder Taxation Manual.

Policy pays out on death

If the policy pays out on your death, your estate will only pay tax on the difference between the surrender value and the premiums you paid, even where the total benefits paid out from the policy are more than the surrender value. This is so that you are only taxed on the profit you make from the investment up to the date of your death and not on any life insurance element. This is called the ‘mortality profit’.