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Ruth, aged 66, has an income of £22,900
in 20010–11. This is the maximum she can have without losing any
personal allowance so she qualifies for the full amount for someone
aged 65 to 74 of £9,490 and her tax bill for the year is set to be
£2,682. However, she decides to cash in a single-premium
life-insurance policy, making a gain of £2,000. This increases her
income to £24,900. Although she is still a basic rate taxpayer and
there is no tax for her to pay on the gain itself, her tax bill
increases to £2,882. This is because her personal allowance is
reduced by £1 for every £2 of income above £22,900. Therefore the
£2,000 gain reduces her personal allowance by £1,000. This puts an
extra £1,000 of her income into the basic rate tax band adding £200
to her tax bill.
In 2010–11 Jim, aged 48, has earnings of £43,000 and also
makes a life insurance gain of £5,000 on a policy that has run for
five years. At first sight, £875 of the gain falls within Jim’s
basic-rate band, leaving £4,125 to be taxed at 40% – 20% = 20%, a
tax bill of £825. However, because the gain takes Jim over a
tax-rate threshold, top-slicing relief applies. The gain of £5,000
is divided by the number of years the policy has run, which is
five. This gives an average gain or ‘slice’ of £1,000. So £875 of
the slice falls within Jim’s basic-rate band, leaving £125 to be
taxed at 40% – 20% = 20%. Therefore, tax on the slice is £25 and
tax on the whole gain is reduced to 5 × £25 = £125.
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