When an investor disposes of a traded endowment policy (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 TEP, 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

Commencement Date19 Mar 1986(Start date of policy)
Disposal Date27 Mar 2006(End date of policy)
Investment Date19 Feb 2001(Date policy was purchased as a TEP)
Purchase Price-11,500(Price paid for the TEP)
Monthly Premium27.00(Monthly payments made following purchase)
Disposal Proceeds21,900(Amount realised on Disposal Date)
Assumed Inflation 3% per annum (Assumed annual inflation)

Capital Gain Calculation:

Disposal Proceeds21,900(Amount realised on Disposal Date)
Purchase Price-11,500(Price paid for the TEP)
Investment Date19 Feb 2001(Date policy was purchased as a TEP)
Premiums Paid By Investor1,620(Total of Monthly Premiums following purchase)
Chargeable Event8,780(The profit)
Tapering relief1.326(Tax relief for non business assets held for 10 years)
Taxable Gain7,454(Taxable gain to be offset against the investor's Capital Gains Tax Allowance)

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, and now 11,100) 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%-18%=22%) as at April 2001 for the above example, and is 20% (40%-20%) this tax year 2016-2017. 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".

In simple terms 'top slicing' allows the actual gain to be divided by the whole number of tax years the investment has been held. This figure is then added to your taxable income for the year in which the policy matured and according to where the "slice" straddles various tax bands, a proportional tax rate is the applied to the whole real gain etc. etc.

Do not rely on this truncated definition of top slicing - You should discuss top slicing with an accountant because it is complex.

Making your TEP more tax efficient

The following approaches may help you to offset Capital Gains Tax.

  • Purchase the TEP in two names so the tax free gain would be 14,400 (in 2001).

  • Rather than purchasing one larger TEP, it may be more tax efficient to purchase a number of smaller TEPs with maturity dates spanning different tax years.

  • Under current legislation, you may give a TEP to your spouse as a gift, and provided that you continue to pay the premiums, your partner would not be subject to Capital Gains Tax upon disposal.

N.B. This 'loophole' has been recognised by the Inland Revenue and may be closed at some time in the future.

TEPs are recognised by the Pensions Schemes Office, and as such are permitted investments for both Small Self Administered Schemes (SSASs) and Self Invested Pension Plans (SIPPs), and within these environments attract no tax upon disposal.

Note: For overseas investors, gross returns on a TEP will be subject to the tax laws applicable to the country in which you are considered to be resident at the time of disposal.

Further information on Capital Gains Tax can be found at the GOV.UK website.