Burden on investors to assess impact of change in tax regime for life assurance

Do you ever get the feeling you have missed the boat? Starting in the new year, many life assurance companies will be extolling the virtues of gross roll-up and marketing "superior" investment products to make the most of the new tax regime.

Does that mean that your existing policy is inferior? Probably not. Gross roll-up has advantages and disadvantages and, with a little help, you should be able to work out what is best for you. The new system of taxing the profits of a policy on exit will replace the system where the profits are taxed within the fund on an annual basis. From January 1st, it will apply to anything you buy from a life company excluding pensions, permanent health insurance and annuities. Life companies took in more than £2 billion (€2.54 billion) in life business last year and the figures for this year are already well up on that. With a few exceptions, most companies have been selling policies this year that do not incorporate an automatic switch to the new tax regime. That is not to say investors will necessarily lose out by sticking with their policies. It is up to each policyholder to establish whether they would be better off switching and there is a lot to take into account. First let's get a clear definition of what gross roll-up is. According to the Irish Insurance Federation, gross roll-up is a term that describes life assurance investment funds that are not subject to tax as they accumulate.

Traditionally this has applied only to pensions and, more recently, to insurers selling overseas from the International Financial Services Centre. Other life assurance funds paid tax each year but the policyholder had no further tax to pay when they received any payment from the policy. From January 1st, 2001, all new life assurance policies will be on a gross roll-up basis.

No tax will be paid by the fund but an exit tax of 25 per cent will be deducted by the insurance company from the profit paid to policyholders. There is still no personal tax liability to worry about as tax is paid at source by the fund managers.

To switch or not to switch? That will be the question for policyholders from next month. The Society of Actuaries has released a position statement on life assurance taxation changes, which is a useful starting point for those seeking information on the pros and cons of switching.

The society welcomes the taxation changes but cautions that there are policyholder issues that will need careful consideration.

In its position statement, the society says that there is no definitive answer to the question of whether existing policyholders are better off under the existing or the new tax regime. The answer depends on the exact terms of the existing policy and the exact terms of the new policy. With that caveat firmly in place, the society goes on to make some general statements: [SBX]

If there is an entry charge for the new policy it is unlikely that the customer will benefit from a switch.

If the new policy has higher ongoing charges it is unlikely that the customer will benefit from a switch.

The higher the cost of exit on the existing policy the less likely it is that the customer will be better off after a switch.

Future changes in the basic rate of tax may also affect the balance of taxation paid between a gross roll-up policy and a policy under the existing system.

There is also the question of the return on the investment. With the new tax regime more money will remain in the fund, which should ultimately lead to higher returns. The Society of Actuaries says that customers should ask their adviser and/or insurance company for a set of projected future values for the existing policy and for the new policy. One policy may give higher values in the shorter term while the other may offer better longer term values. Customers will need to consider their likely investment time frame before making the final decision. To get back to charges, it is expected that policies available from January 1st may have higher charges as companies reprice to make up for loss of profits.

According to Ms Jennifer Hoban of the insurance federation, it seems likely that the cost of basic protection policies will rise in the new regime. "Such policies have higher set-up costs because of the underwriting process and under the current regime the life company gets tax relief on this expenditure. In the new regime this tax relief will not be available so the overall cost is likely to rise."

Will that cost be passed on to the customer? Some companies have declared their commitment not to increase management charges in the new regime. Of course, they can always change their minds in a few months. Other companies are still doing their sums and have not decided whether to absorb or pass on the pain. All will be revealed in January.

This is a complex area but each policyholder is responsible for navigating their own way through it. Ms Hoban says it is not practical to expect insurance companies to review every situation. "The policyholder has to take the initiative on this and check it out themselves. Nothing will happen automatically so it is important to go and talk to whoever usually advises you on insurance," she says.

One final feature of gross rollup is that payments on death and disability or to non-residents will be exempt from the exit tax. Mr Alan Morton of Money wise financial advisers sees this as an important benefit for holders of joint name policies. "Traditionally joint life, second death policies were the standard for married couples. But with gross roll-up this will now change to joint life, first death. The benefits will then transfer to the surviving partner with no tax liability."