Free CII R05 Practice Questions: Protection Policy Taxation

CII means Chartered Insurance Institute. R05 is Financial Protection in the Diploma in Regulated Financial Planning. Use this focused CII R05 page as a short practice test for Protection Policy Taxation. The items are original Finance Prep sample exam questions built for scenario-based practice, not trivia, puzzle questions, official CII questions, copied live-exam content, or exam dumps.

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These are original Finance Prep practice questions aligned to this topic area. They are not official CII questions, copied live-exam content, or exam dumps. Use them to preview question style and explanation depth before continuing with topic drills, mixed sets, and timed mock exams in Finance Prep.

Question 1

Topic: Taxation of Life Assurance and Pension-Based Protection

Maya is UK resident and a higher-rate taxpayer. She is reviewing the tax position before fully surrendering this policy in the 2025/2026 tax year.

Policy summary:

Which interpretation is most relevant to Maya?

• A. A capital gain of £15,000 arises, calculated as the surrender value less the original premium, and is subject to Capital Gains Tax.
• B. A chargeable event gain of £35,000 arises and is assessed under Income Tax, with basic-rate tax treated as paid because the policy is onshore.
• C. A chargeable event gain of £15,000 arises and is taxable with no basic-rate tax credit because the policy is non-qualifying.
• D. No taxable gain arises because the withdrawals were within the cumulative 5% allowance and the bond is onshore.

Best answer: B

What this tests: Taxation of Life Assurance and Pension-Based Protection

Explanation: For a full surrender of a non-qualifying life assurance bond, the chargeable event gain is broadly the surrender value plus previous withdrawals, less the amount invested and any earlier chargeable event gains. Maya’s gain is therefore £95,000 + £20,000 - £80,000 = £35,000. The gain is dealt with under Income Tax, not Capital Gains Tax. Because this is a UK onshore bond, basic-rate tax is treated as already paid within the fund. As a higher-rate taxpayer, Maya may have a further Income Tax liability, subject to the normal chargeable event gain rules such as top-slicing relief where applicable.

• Treating the result as a capital gain uses the wrong tax regime for a life assurance bond surrender.
• The 5% withdrawal facility defers tax during the policy term; it does not remove the withdrawals from the final surrender calculation.
• Using only the surrender value less the premium ignores previous withdrawals, and an onshore bond does carry basic-rate tax treated as paid.

The gain is £95,000 plus £20,000 less £80,000, and an onshore bond gain is subject to Income Tax with basic-rate tax treated as paid.

Question 2

Topic: Taxation of Life Assurance and Pension-Based Protection

Amira is the sole shareholder and managing director of a trading company.

Facts:

• The company has a £500,000 bank loan that would become immediately repayable if Amira died.
• The bank wants evidence that funds would be available to repay the loan.
• Amira’s stated priority is to keep the company solvent and protect employees if she dies.
• Her accountant suggests a relevant life policy because the company may pay the premiums tax-efficiently and the proceeds can usually be kept outside Amira’s estate by using a trust for her family.
• Amira also has a separate family protection need, but it is not her immediate priority.

What is the best professional response?

• A. Arrange pension-based term assurance because tax relief on premiums should take priority over the company’s access to the claim proceeds.
• B. Recommend a company-owned life policy for the loan repayment need, and consider separate family protection such as relevant life cover if appropriate.
• C. Use the relevant life policy because its tax treatment makes it the most efficient way to protect the company loan.
• D. Write the relevant life policy in trust for Amira’s family and ask them to repay the company loan from the proceeds.

Best answer: B

What this tests: Taxation of Life Assurance and Pension-Based Protection

Explanation: Tax planning should support the protection objective, not replace it. Amira’s immediate risk is a company liability that becomes repayable on her death, so the cover must provide money to the company or lender when needed. A relevant life policy can be tax-efficient for death-in-service style family protection, and trust planning may keep proceeds outside the estate, but that structure is not designed to repay a company loan. If proceeds are paid to family trustees, the company cannot rely on them for loan repayment. The adviser should first match the policy structure to the business need, then consider tax treatment and any separate family protection need.

• A relevant life policy may be suitable for family protection, but it does not meet a company loan repayment objective if proceeds are outside the company’s control.
• Relying on family trustees to repay the loan creates uncertainty and does not satisfy the bank’s need for reliable business protection.
• Pension-based cover or premium tax relief is not the deciding factor where the main objective is company access to claim proceeds.

The policy ownership and beneficiary must match the company loan objective, rather than allowing tax efficiency to divert the proceeds away from the business need.

Question 3

Topic: Taxation of Life Assurance and Pension-Based Protection

Amira is the sole director-shareholder of a UK trading company. She wants £800,000 of life cover so that her spouse and children receive a lump sum if she dies during the next 20 years.

Client and company facts:

• The company will fund the premiums if this is tax-efficient.
• The family, not the company, must receive the benefit.
• Amira does not want the proceeds exposed to company creditors.
• There are no other employees to include in a group arrangement.
• The policy would have no surrender value or investment element.

Which recommendation is most appropriate?

• A. Arrange a relevant life policy, paid for by the company and written under a suitable discretionary trust for Amira’s family.
• B. Arrange a personal term assurance policy paid from Amira’s net income and left to pass under her will.
• C. Arrange a company-owned keyperson policy, with the company promising to pass any proceeds to Amira’s family.
• D. Arrange a registered group life scheme for Amira alone, with the company named as beneficiary.

Best answer: A

What this tests: Taxation of Life Assurance and Pension-Based Protection

Explanation: The purpose of the cover is family protection, not business continuity. A relevant life policy is designed for an employer to provide life cover for an employee or director on an individual basis. Premiums are paid by the company and are normally not treated as a taxable benefit for the employee, provided the policy meets the relevant conditions. The proceeds are usually written under trust, so the family can receive the benefit directly and it is not an asset of the company. This also helps keep the benefit outside Amira’s estate for Inheritance Tax purposes. A keyperson policy is normally owned by the business and pays the business, which does not match the required benefit delivery. A personal policy could work for family protection, but it is less tax-efficient here because Amira would fund it from taxed income and it needs trust planning to avoid estate delays or IHT exposure.

• Company-owned keyperson cover pays the company, so it is aimed at protecting business profits or debt rather than providing direct family benefit.
• Personal term assurance can protect the family, but paying from net income and relying on a will does not meet the tax-efficiency and direct-delivery aims as well.
• A registered group life scheme is unnecessary for a single-person case here, and naming the company as beneficiary conflicts with the family-protection objective.

A relevant life policy can provide employer-funded death-in-service style cover with no employee benefit-in-kind charge and benefits paid through trust to the family rather than the company.

Question 4

Topic: Taxation of Life Assurance and Pension-Based Protection

A protection adviser is reviewing Liam’s life assurance arrangements after he bought a flat with his long-term partner, Maya. They are not married or in a civil partnership.

Policy and tax summary:

• Liam owns a level term assurance policy on his own life.
• Sum assured: £250,000.
• Beneficiary nomination: none; the insurer would pay the proceeds to Liam’s personal representatives.
• The policy has no surrender value.
• Liam’s estate excluding the policy is valued at £600,000.
• Available nil-rate band: £325,000.
• Assume no residence nil-rate band, no transferable nil-rate band and no spouse or civil partner exemption.
• Inheritance Tax is charged at 40% on the taxable estate above the available nil-rate band.

Which conclusion is most relevant to the protection advice?

• A. The death benefit will be free of Inheritance Tax because life assurance proceeds are always exempt when paid on death.
• B. If Liam dies while the policy is not in trust, the £250,000 proceeds may increase the taxable estate and add about £100,000 to the Inheritance Tax exposure.
• C. Maya will automatically receive the policy proceeds free of tax because she is Liam’s long-term partner and lives in the flat.
• D. The policy should be surrendered before death to prevent an Income Tax charge on the full £250,000 sum assured.

Best answer: B

What this tests: Taxation of Life Assurance and Pension-Based Protection

Explanation: Life assurance proceeds are usually free of Income Tax and Capital Gains Tax when paid on death, but Inheritance Tax depends on ownership and destination of the proceeds. Here, the policy is owned by Liam and is not written in trust. If the insurer pays £250,000 to Liam’s personal representatives, the proceeds are likely to form part of his estate. The estate would increase from £600,000 to £850,000. With only a £325,000 nil-rate band available, the extra £250,000 creates an additional IHT exposure of £100,000 at 40%. A trust may be relevant because it can keep the proceeds outside the estate and can also help payment reach intended beneficiaries more quickly.

• Treating all death benefits as automatically IHT-free confuses Income Tax treatment with estate taxation.
• Surrender is not relevant for a level term policy with no surrender value and does not address the IHT issue on death proceeds.
• Cohabitation does not create the spouse or civil partner exemption, and a partner does not automatically receive policy proceeds without suitable ownership, nomination, trust or will planning.

The policy proceeds paid to the estate would raise the estate from £600,000 to £850,000, increasing taxable value by £250,000 and IHT by 40% of that amount.

Question 5

Topic: Taxation of Life Assurance and Pension-Based Protection

Amira and Daniel are married, UK resident and domiciled. They have two adult children and a mortgage-free home plus investments. Their adviser estimates that, after both deaths, their combined estates are likely to produce an Inheritance Tax liability.

They also have an existing joint-life first-death term assurance policy. Its main purpose is to provide capital for the surviving spouse if one of them dies before retirement.

They want to reduce the risk that their children will need to sell assets to pay IHT, but they do not want to weaken the surviving spouse’s protection.

Which recommendation best meets both aims?

• A. Leave all policy proceeds payable to the estate so the executors have maximum control over paying tax and distributing assets.
• B. Keep the first-death protection for the surviving spouse and consider a separate joint-life second-death whole of life policy written in trust to help fund the IHT liability.
• C. Assign the existing first-death term assurance policy absolutely to the children so its proceeds can be used to pay any IHT due.
• D. Cancel the existing term assurance and replace it with a single-life policy on the older spouse written for the children.

Best answer: B

What this tests: Taxation of Life Assurance and Pension-Based Protection

Explanation: Life assurance can support estate planning by providing cash when an IHT liability is expected, especially where beneficiaries might otherwise have to sell illiquid assets. For a married couple, the main IHT liability will often arise on the second death because transfers between spouses are generally exempt. A joint-life second-death whole of life policy is therefore commonly used to match that timing. Writing the policy in a suitable trust can keep the proceeds outside the insured estate and make funds available more quickly to the intended beneficiaries or trustees. The existing first-death term policy has a different protection purpose: it supports the surviving spouse. Diverting or cancelling it would solve one problem by creating another protection gap.

• Assigning the existing first-death policy to the children may remove flexibility and undermines its purpose of protecting the surviving spouse.
• A single-life policy on one spouse does not match the usual second-death IHT need for a married couple and may leave the survivor exposed.
• Paying proceeds to the estate can delay access through probate and may increase the estate value for IHT purposes.

A second-death policy in trust targets the likely IHT timing while preserving the first-death cover for the surviving spouse.

Question 6

Topic: Taxation of Life Assurance and Pension-Based Protection

A UK-resident client is comparing two single-premium life assurance investment bonds to hold for at least 10 years:

• One bond invests in a UK onshore life fund.
• The other bond invests in an offshore life fund.
• The client is mainly interested in how the funds are taxed while invested.
• The client says: “If both are life assurance policies, I assume the gains are taxed under Capital Gains Tax rules when I encash.”

What is the best professional response?

• A. Recommend the offshore bond because offshore life fund growth is always tax-free for a UK-resident individual when the policy is encashed.
• B. Recommend the onshore bond because the client can reclaim the tax paid by the UK life fund if they are a basic-rate or non-taxpayer at encashment.
• C. Explain that both funds are taxed internally in the same way, so the client’s only tax difference will be the Capital Gains Tax annual exempt amount at encashment.
• D. Explain that the onshore life fund is taxed internally on income and gains, while the offshore fund generally rolls up without UK life fund tax; any later chargeable event gain is normally subject to Income Tax, not Capital Gains Tax.

Best answer: D

What this tests: Taxation of Life Assurance and Pension-Based Protection

Explanation: UK onshore life funds are subject to tax within the fund on income and gains. For an individual policyholder, this means tax is generally treated as having been paid at basic-rate level on a later chargeable event gain, although higher or additional rate taxpayers may have further Income Tax to pay. Offshore life funds usually benefit from gross roll-up, apart from possible local taxes or withholding taxes, but no UK basic-rate tax is treated as paid. When a chargeable event arises, such as full surrender, the gain is normally assessed under Income Tax rules rather than Capital Gains Tax rules. The key comparison is internal taxation now versus possible tax deferral and later Income Tax exposure.

• Treating both funds as taxed identically misses the internal tax suffered by UK onshore life funds.
• Describing offshore growth as always tax-free confuses tax deferral with exemption for UK-resident policyholders.
• Suggesting a reclaim of onshore life fund tax is wrong because the deemed basic-rate tax cannot normally be reclaimed by non-taxpayers or basic-rate taxpayers.

This correctly distinguishes onshore and offshore life fund taxation and the usual Income Tax treatment of chargeable event gains.

Question 7

Topic: Taxation of Life Assurance and Pension-Based Protection

Leila, aged 47, owns a 20-year qualifying endowment policy on her own life, with five years remaining. She has been the beneficial owner since outset.

Client facts:

• The policy is not in trust and is not assigned to a lender.
• The current mortgage balance is £70,000.
• The policy has a basic sum assured of £80,000 plus bonuses.
• Her partner and young child rely on her income.
• She has no other life cover.
• The surrender value is £42,000, but a traded endowment policy buyer has offered £46,000 and would pay future premiums.

Leila says, “The traded policy offer looks better, and the policy will still be on my life, so my family should still be protected.”

What is the best adviser conclusion?

• A. The sale may not create a tax charge for Leila, but it would remove the mortgage and family protection because the buyer would receive the policy proceeds.
• B. The sale should be avoided solely because Leila will necessarily pay Capital Gains Tax on the sale proceeds less premiums paid.
• C. Surrender is preferable because surrender proceeds are never taxable, whereas traded policy sale proceeds are always taxed as income.
• D. Leila can sell the policy and keep the protection by putting it into trust for her family immediately before completion.

Best answer: A

What this tests: Taxation of Life Assurance and Pension-Based Protection

Explanation: A traded endowment policy transaction can improve the cash received compared with surrender, but the protection outcome changes fundamentally. If Leila sells the policy, the purchaser becomes entitled to the maturity or death proceeds and pays the future premiums. The policy may still be on Leila’s life, but it no longer protects her mortgage or dependants. On the facts given, she was the original beneficial owner of a qualifying policy, so the immediate tax issue for her is not the strongest reason to reject or delay the transaction. The adviser should first address the loss of life cover, assess replacement protection, affordability and underwriting, and only then consider whether selling is suitable. The purchaser of a traded policy may face CGT considerations later because the policy has been acquired for consideration.

• Treating the sale as necessarily subject to CGT for Leila misapplies the traded policy rules to the original owner of a qualifying policy.
• Saying surrender is always tax-free and traded sales are always income-taxable is too broad and reverses the main issue here.
• A trust cannot allow Leila to receive the sale proceeds while her family also keeps the death or maturity benefit sold to the buyer.

As the original owner of a qualifying policy, Leila’s sale is not the main tax concern; the key issue is that the protection benefit would belong to the purchaser.

Question 8

Topic: Taxation of Life Assurance and Pension-Based Protection

An adviser is reviewing protection for Priya, a higher-rate taxpayer who is UK resident and domiciled. She wants family protection for 18 years while her children are dependent.

Protection need and existing policy:

• Required lump sum on death: £250,000
• Existing onshore non-qualifying life assurance bond:
  • Original investment: £40,000
  • Current surrender value: £55,000
  • Death benefit: 101% of fund value (£55,550)
  • Not written in trust
• If fully surrendered now, chargeable event gain before any reliefs: £15,000
• Proposed new level term assurance:
  • Sum assured: £250,000
  • Term: 18 years
  • Premium: £22 per month, affordable for Priya
  • Can be written in trust

Which conclusion is the best interpretation?

• A. The new term assurance better matches the protection need; the bond’s chargeable event taxation is a separate issue and does not make its £55,550 death benefit suitable.
• B. The bond should be surrendered and replaced only if the £15,000 chargeable event gain is fully covered by Priya’s personal allowance.
• C. The existing bond should be treated as suitable protection because onshore bond taxation is generally more favourable than offshore bond taxation.
• D. A qualifying whole of life policy should be recommended because qualifying status is the main factor in determining protection suitability.

Best answer: A

What this tests: Taxation of Life Assurance and Pension-Based Protection

Explanation: Protection suitability starts with the client’s need: amount, term, affordability, ownership and claims destination. Priya needs £250,000 for 18 years, while the existing bond would pay only £55,550 on death, leaving a £194,450 shortfall. Its onshore non-qualifying tax treatment matters if the bond is surrendered or assigned, but it does not convert an investment-style life policy into adequate family protection. A new term assurance policy for the required amount and term, with an affordable premium and the option of a trust, better addresses the protection objective. Taxation should be considered as part of the advice process, but it should not be confused with the suitability assessment of whether the policy meets the identified protection need.

• Focusing on onshore versus offshore taxation misses the main suitability issue: the existing death benefit is far below the required cover.
• Making replacement depend only on personal allowance treatment overstates the tax point and ignores the protection shortfall.
• Qualifying status is a tax classification, not a substitute for matching sum assured, term, affordability and trust planning to the client’s need.

The bond leaves a death-cover shortfall of £194,450, so its tax treatment does not override the suitability need for adequate term assurance.

Question 9

Topic: Taxation of Life Assurance and Pension-Based Protection

A company wants to provide additional life cover for Noor, a director-employee. The cover is intended to provide a lump sum for her spouse if she dies while employed.

Relevant facts:

• Additional cover required: £500,000.
• Existing uncrystallised registered pension fund: £850,000.
• Existing registered death-in-service lump sum: £300,000.
• Lump sum and death benefit allowance assumed for this case: £1,073,100.
• Registered pension death benefits above the available allowance would be taxable on the beneficiary at their marginal rate.
• A relevant life policy would be written in a suitable discretionary trust and would not be tested against this allowance.
• Ignore premium differences and assume the employer meets any conditions for corporation tax relief.

Which interpretation best shows how tax treatment changes the suitability of the recommendation?

• A. A relevant life policy is more suitable, because adding £500,000 through a registered scheme would increase registered lump sum death benefits above the allowance to £576,900.
• B. A pension-based term assurance policy is more suitable, because tax relief on the employee’s premiums removes any concern about the death benefit allowance.
• C. A personal term assurance policy is more suitable, because relevant life policy proceeds are normally treated as part of the employee’s estate for Inheritance Tax.
• D. A registered group life scheme is more suitable, because employer-paid premiums are always tax-free and the death benefit is never taxable.

Best answer: A

What this tests: Taxation of Life Assurance and Pension-Based Protection

Explanation: Tax can change the suitability of otherwise similar life cover where the proposed route affects the tax position of the eventual benefit. Here, Noor already has registered pension-related lump sum death benefits of £1,150,000 (£850,000 plus £300,000), which exceeds the stated allowance of £1,073,100. If the extra £500,000 were provided through a registered group life arrangement, total registered lump sum death benefits would be £1,650,000, leaving £576,900 above the allowance. A relevant life policy written under a suitable trust is not tested against that allowance, so it can provide the required employer-funded life cover without worsening the registered pension death benefit tax exposure.

• Employer premium tax relief does not by itself decide suitability when the main issue is tax on the death benefit.
• Relevant life policies are commonly written in trust and are not normally part of the employee’s estate when correctly arranged.
• Premium tax relief on a pension-based arrangement would not remove the beneficiary tax issue created by exceeding the stated allowance.

The extra registered cover would make total registered lump sum death benefits £1,650,000, so £576,900 would exceed the £1,073,100 allowance.

Question 10

Topic: Taxation of Life Assurance and Pension-Based Protection

Nadia wants a new protection policy to ensure her cohabiting partner can clear their joint mortgage if Nadia dies during the next 20 years. Her partner is not her spouse or civil partner.

Proposed cover and tax facts:

• New level term assurance sum assured: £300,000
• Nadia’s estate excluding the new policy: £525,000
• Available nil-rate band: £325,000
• IHT rate on the excess: 40%
• Ignore residence nil-rate band and any other exemptions.
• If the policy is not written in trust, the proceeds will be paid to Nadia’s estate.

Which conclusion best evaluates whether writing the new policy in a suitable trust supports Nadia’s protection objective?

• A. It supports the objective because an own-name policy would add £300,000 to the estate and could increase IHT by £120,000, whereas trust proceeds can be kept outside the estate for the intended beneficiary.
• B. It is unnecessary because life assurance proceeds are automatically outside the estate for IHT, regardless of ownership or trust status.
• C. It is ineffective because Nadia’s nil-rate band is already partly used, so a trust cannot improve the amount available for mortgage repayment.
• D. It undermines the objective because trust proceeds from a life assurance policy are normally subject to Income Tax before being paid to the beneficiary.

Best answer: A

What this tests: Taxation of Life Assurance and Pension-Based Protection

Explanation: For protection planning, tax treatment should be judged by whether it helps the cover meet the client’s intended need. If Nadia owns the policy personally and it pays to her estate, the £300,000 proceeds increase the taxable estate. With a 40% IHT rate above the nil-rate band, this could create an additional IHT cost of £120,000. A suitable trust can keep the policy proceeds outside Nadia’s estate and direct them to the intended beneficiary, helping the partner clear the mortgage more reliably and usually without waiting for probate. The tax planning therefore supports, rather than distracts from, the protection objective.

• Treating trust proceeds as normally subject to Income Tax confuses life assurance proceeds with taxable income.
• Assuming all life assurance is automatically outside the estate ignores the importance of policy ownership and trusts.
• Saying the trust is ineffective misses the main point: the trust can prevent the policy proceeds themselves from increasing the taxable estate.

Writing the new term assurance in trust aligns the tax treatment with the protection need by reducing the IHT drag and improving access for the intended beneficiary.

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