IPTM3880 - Deficiency relief: calculation of deficiency relief
Deficiency relief is given as a tax reduction in the tax year in which the policy comes to an end. The relief is set off against an individual’s income tax liability for the year.
Deficiency relief is calculated by reference to the various types of income which are attributed to the amount of the deficiency (see IPTM3870 for guidance on how to calculate the amount of deficiency). Only income taxable at the following 'relevant rates' is taken into account when calculating deficiency relief: dividend upper, higher, default higher, savings higher, Welsh higher, Scottish higher and Scottish advanced. If there is no income liable to tax at any of those rates in the tax year the policy comes to an end, then there will be no deficiency relief. Deficiency relief will not reduce the amount of tax due on income liable at the additional rate or the dividend additional rate of income tax.
Deficiency relief is the difference between the tax liability on income at the relevant rate and the tax liability on that income instead liable at the 'appropriate lower rate'.
| Relevant rate | The appropriate lower rate |
|---|---|
|
the higher rate |
the basic rate |
|
the default higher rate |
the default basic rate |
|
the savings higher rate |
the savings basic rate |
|
the dividend upper rate |
the dividend ordinary rate |
|
the Scottish higher rate |
the Scottish basic rate |
|
the Scottish advanced rate |
the Scottish basic rate |
|
the Welsh higher rate |
the Welsh basic rate |
Income is to be attributed to the deficiency in a way which results in the highest tax reduction. This means first attributing to the deficiency the income where there is the biggest difference between the relevant rate and the appropriate lower rate. Then attributing the income where there is the second biggest difference and so on, until the deficiency is exhausted or there is no further income which can be attributed to the deficiency.
Example
In the tax year 2024/25, Lisa fully surrendered her life insurance policy, bringing her policy to an end. The final surrender gave rise to a deficiency of £10,000.
In the same tax year, Lisa had £4,000 of dividends taxable at the dividend upper rate and £10,000 of other income taxable at the higher rate. To result in the highest tax reduction when calculating deficiency relief, her income is attributed to the deficiency as follows.
- £4,000 of the dividends taxable at the dividend upper rate is attributed to the deficiency. This means that instead of taxing £4,000 at 33.75% (tax due of £1,350), £4,000 is treated as taxed at the dividend ordinary rate of £8.75% (tax due of £350). The reduction in tax is £1,000.
- Lisa still has £6,000 of deficiency available. £6,000 of her income taxable at the higher rate is attributed to the remaining deficiency. Instead of taxing £6,000 at 40% (tax due of £2,400), £6,000 is treated as taxed at the basic rate of 20% (tax due of £1,200). The reduction in tax is £1,200.
Deficiency relief is the sum of the two reductions calculated above, that is, £1,000 plus £1,200 which equals £2,200. This is set off against Lisa’s tax liability for the year.
Exception for certain life annuity contracts
The only exception to the rules described above is in the rare case of a life annuity contract made:
- after 26 March 1974, but
- in an accounting period of the insurer beginning before 1 January 1992.
If deficiency arises on such a contract, then it is given as a deduction in full against total income, without restriction.