Pension term assurance - life assurance with tax breaks

The appeal of pension term assurance (PTA), thanks to the rule changes that come with A Day (6 April 2006), lies in the tax relief of up to 40%. PTA looks set to be the latest buzz acronym in the world of financial products.

Pension term assurance is not a pension; it's a term life assurance in a pension wrapper. Yes, the tax relief on premiums is to be welcomed, but as with all term life insurance unless you die within the specified policy timeframe (usually 25 years) there is no payout.

If you do "check out" within the term, then your dependants or beneficiaries need to be prepared for a possible punitive tax charge. This is because a PTA policy payout counts towards your total pension fund value; if this value exceeds the new lifetime limit of £1.5 million a tax charge of 55% is incurred on the excess.

If your pension pot is already above the £1.5 million (lucky you!) and you have opted for enhanced protection, then taking out PTA may render that null and void, so making you liable to the tax charge. Otherwise, in the event of your death, the level of PTA cover agreed will be paid out as a lump sum, free from inheritance tax (it is in trust and thus falls outside your estate for IHT purposes).

What has changed to make PTA so attractive?

Why the seemingly sudden interest in pension term assurance, a product, after all, that's been available for years? Offer thanks to A Day and the introduction of new pension rules. Hitherto you had to make contributions to a pension before being allowed the life cover option and it was limited to a maximum of 10% of your pension contribution.

Both these restrictions are scrapped effective 6 April 2006. You will not need a pension or have to start one in order to take advantage of PTA and the tax relief on the insurance premiums will be the same as that for pension contributions. This could mean a saving on every £100 of £40 for higher rate taxpayers and £22 for those on the basic tax rate.

Anyone under the age of 75 can contribute to a PTA with the maximum per annum being 100% of UK earnings or £3,600, whichever is the higher. There will be no limit to the amount of pension term assurance that can be held, but tax relief will only be given if the total of the pension and term assurance contributions are below the annual allowance (£215,000 initially).

Is pension term assurance for you?

Because of the tax savings does it make sense to take out a PTA instead of normal term assurance? If you already own the latter should you switch policies to this more tax-efficient life insurance method? On the face of it premiums will be lower; it has been calculated that, over a 25 year period, a £20 per month PTA contract could generate savings of between £1,320 and £2,400, depending on your tax status.

However, before joining the stampede to tax relief heaven, be aware of certain considerations and possible drawbacks.

Higher administrative costs, caused by the rules regulating the way life insurers deal with pensions, are expected to hike the cost of PTA premiums by between 5% and 15%, compared to normal term assurance. This will partially negate the tax relief benefit.

Premiums may be lower in a few months' time as more providers enter the PTA market and it becomes more competitive. At the moment not all companies are ready to go from April; Standard Life and Liverpool Victoria are among those who are but Norwich Union and Legal & General are not expected to enter the market until later in the year.

However, all companies are said to be refusing to continue existing terms and conditions if you simply want to switch from normal term life assurance to a PTA contract. You will have to terminate your present policy and start a new one, with all the attendant problems that may arise from fresh underwriting. At the very least, regardless of any specific health deterioration, your new premiums will be the higher the longer your existing life insurance has been in force.

Will switching to PTA be worthwhile?

There are no add ons to pension term assurance, such as critical illness cover or family income benefit arrangements, often a feature of standard life insurance. Also joint life policies don't appear to be an option.

If you're a high rate taxpayer the 40% relief is an obvious attraction, but how close are you to the lifetime allowance of £1.5 million? Would your dependants welcome a 55% tax savaging?

According to the Financial Services Authority, after 6 April 2006 pension term assurance can be sold without the need for accompanying financial advice. This omission does not sound sensible, especially if you are planning to switch to a PTA and your years are advanced. You should always seek independent professional advice on financial matters concerning protection and retirement.

30 March 2006 © Moneyextra.com

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