The Taxation of BLAGAB Products

Changes to the rate of capital gains tax and dividends applying from 6th April 2016 have an impact on the decision of whether to invest in equities via an insurance policy taxed as a BLAGAB business or via direct investment.

The changes are: The introduction of an effective 7.5% surcharge on dividends received by individuals. Dividends received by an insurance company in respect of BLAGAB business are not taxable and there is no adjustment to the tax rates applying when a policy is surrendered  / matures which remains at 20% for higher rate tax payers and 25% for additional rate tax payers.  Accordingly the new dividend rules give a BLAGAB policy an advantage over direct investment.

However, the rate of tax for additional and higher rate tax payers on capital gains is reduced to 20% from 6th April 2016.  Capital gains in a BLAGAB insurance product are taxed at 20% but with an allowance for inflation (indexation allowance) not available to individuals.  There will be an additional tax charge for additional  / higher rate tax payers on surrender / maturity of 20% for higher rate payers and 25% for additional rate payers.  Accordingly, for higher and additional rate tax payers even before considering capital gains tax allowance, capital gains on direct investment are taxed more lightly than capital gains on an asset held in a BLAGAB insurance policy.

I ran a few numbers to see under what circumstances it could still be beneficial to invest in a BLAGAB insurance policy.  Obviously one set of circumstances where a BLAGAB product can be useful is deferring the incidence of taxation from a period when an individual is a higher or additional rate tax payer to a period when they pay tax at a lower rate (that is the higher rate and additional rate charge is levied on the tax payer only when the product is surrendered or matures).

Ignoring the possibility of deferring taxation until a lower rate of tax applies then whether it is better to invest in equities via a BLAGAB product or via direct investment depends on the availability of the capital gains tax allowance and the split of investment return between dividends (where the BLAGAB policy does better) and capital gains (where direct investment does better).

In the short term direct investment might well be better as you would hope that capital gains would be a significant element of total returns and the availability of capital gains tax allowance would be significant.  Over longer periods however a BLAGAB policy becomes a better bet as capital gains tax allowance is not so relevant and the percentage of total returns made up from dividends increases.  In fact there is some evidence that if you look at a long enough period most of the return from equities comes from (reinvested) dividends and capital appreciation is matched by inflation. In these circumstances a BLAGAB policy stacks up very well against direct investment.

So perhaps still a role for BLAGAB insurance products investing in equities albeit a niche product as hard to see as useful for individuals who are in a position to pay into ISAs or pensions.