The financial services regulators are already cracking down on the indiscriminate use of "guaranteed". All too often, the word has been accompanied by a mass of small print limiting its value.
Now, "tax-free" is in the firing line. At the end of November, the Inland Revenue published proposals to restrict the tax benefits from life policies. These proposals won't become law until at least 1998, but they apply to existing as well as new policies. Everyone who has a life policy, or who may buy one in the future, should know how the Revenue plans to tax their life policy investment.
The first, and most welcome, news is that the Revenue intends to continue the income tax exemption for mortality or morbidity returns under a life policy, ie the extra payment over and above the investment value of the policy, paid out on death, disability or critical illness. The Revenue's attentions are directed elsewhere, to the investment benefits that a life policy can bring.
At present, a life policy that meets certain qualifying conditions - broadly, premiums that are payable regularly for at least 10 years, with a death benefit equal to at least 75 per cent of total premiums - is exempt from income tax when it matures, on death or at the end of the policy period, or on surrender after at least seven-and-a-half years.
This tax exemption will continue for this type of policy, although some conditions required will be less onerous. But the exemption will not apply to the policy itself, as it does at the moment, where it is certified as being a qualifying policy from outset. Instead, the tax exemption will be determined when the policy matures, or on surrender, and will depend not only on what has happened to the policy since inception, but also who owns the policy at the time of the taxable event.
As currently drafted, these new rules will apply not only to new policies, but to pre-existing ones. This should not cause problems with policies which are still owned by the life assured, or his/her spouse.
But many policies are issued under trust, perhaps to avoid probate delays or death duties, and, in these circumstances, there could well be a charge to income tax on maturity or surrender, even though the policy meets the current qualifying conditions.
So, no longer will the insurance industry be able to advertise these regular premium policies as being guaranteed "tax free"; freedom from tax will be determined in future only when the policy matures or is surrendered, and that will depend on what has happened to it and, possibly, who owns it.
Another favourite expression, "tax-free income" looks set for the chop.
At present, an investor can withdraw up to 5 per cent of the original value of a life policy each year for 20 years, without any immediate liability to higher rate tax in the case of a UK life policy investment, or basic rate and higher rate tax in the case of an offshore policy investment. Any tax on these withdrawals, which are widely marketed as income, is deferred until the policy comes to an end.
When the legislation comes into force, these income withdrawals, even from existing policies, will be subject to tax: the Revenue will identify how much of the withdrawal represents investment profit in the policy and tax that part of the withdrawal either to higher rate tax, in the case of a UK or European Union policy, or to both basic and higher rate tax in the case of an offshore policy.
Various other tax avoidance techniques are also being attacked: the notorious "dead settlor" exemption - where a policy escapes tax if it is held in trust, and the person creating the trust has died - will go, and gifts of policies, currently free of income tax, will fall within the income tax net. This even applies to gifts between spouses, the first time that the Revenue has ever attempted to tax such husband and wife transactions.
Although the proposed new rules are subject to consultation, the thrust of the Revenue's intentions is clear. So anyone considering the purchase of a long-term life policy should treat with caution any claims by the insurance salesman that future profits will be "tax free"n
Michael Bryant is marketing director of Rathbone Brothers, the private client broker and fund management firm.Reuse content