Personal Finance Jamboree – Part 2

Personal Finance

Continuing from the previous article, Personal Finance Jamboree Part 1, we detail Personal Finance issues that our clients may want to look at and ensure are covered. In Part 1, we detailed life assurance, pension nomination forms, wills and state pension entitlement. In this article we’re taking a detailed look at investment bonds.

Investment Bonds

We are not talking here about Bank and Building Society accounts which are often referred to as “Bonds” but investment bonds usually managed by investment houses or insurance companies.

Generally, such investments are subject to life assurance taxation rules. The main points to note being:

  • The investor can withdraw up to 5% per annum of the original capital and such withdrawals are treated as withdrawal of capital and not subject to tax at the time the funds are withdrawn
  • The 5% per annum (if not drawn) can be carried forward and used in later years
  • The 5% withdrawals can be made for a maximum of 20 years
  • Any withdrawals in excess of the 5% are treated as chargeable event gains (CEG) and any such gain is subject to income tax (not capital gains tax)
  • If the bond is “onshore” (UK based) any CEG comes with a notional 20% tax credit. As this is a notional tax credit it cannot be repaid but can be used to extinguish any basic rate tax liability for the individual.
  • If the individual is a higher rate tax payer, there will be an income tax liability on the surrender of the Bond or partial encashment or on withdrawals in excess of the 5% per annum mentioned above
  • Top slicing is available on any CEG based on the number of years the bond has been held

It’s the encashment or partial surrender of such Bond Investments that extreme care needs to be taken to avoid what can be significant potential tax charges. It is therefore imperative that proper advice is sought BEFORE any encashment or partial surrender of the bond is actioned.

The Bond is usually written in a number of “segments” – this can assist with any planning around encashment or partial surrender.

Firstly, the policy segments are assignable between husband and wife. So, if the investment is in the name of one spouse and encashment is being planned, consider whether the other spouse is a lower rate taxpayer and if so, assign the policy to the other spouse before encashment or partial surrender.

As an example – W took out an investment bond 10 years ago for £100,000. No withdrawals have been taken out and W is now looking to cash in the entire investment which is now worth £200,000. W is a higher rate tax payer earning £50,000 per annum; H (her spouse) is basic rate taxpayer earning £20,000 per annum.

If W encashes the whole investment, the chargeable event gain triggers of £100,000 (proceeds less original cost). As the bond has been in place for 10 years, the top sliced gain is £10,000. This is added to W’s income to ascertain the tax rate that she will pay on the gain. As she is already a higher rate taxpayer, the applicable tax rate will be 40%. The tax on the CEG will therefore be

  • Total CEG                               £100,000
  • Tax payable @ 40%             £40,000
  • Notional tax credit – 20% (£20,000)
  • Tax due on encashment     £20,000

If W had assigned the bond to H (as he is a basic rate taxpayer) prior to encashment and H encashes the bond, the tax would be

  • Total CEG                                £100,000
  • Tax payable @ 20%              £20,000
  • Notional tax credit – 20% (£20,000)
  • Tax due on encashment      £Nil

A saving of £20,000 by just applying some simple planning steps. And the position could have been even worse for W if she was claiming child benefit as the CEG would have been treated as income for the purposes of the High Income Child Benefit Charge and she could have been having to pay all of this benefit back to HMRC!

A tax case has highlighted another issue with regards to partial surrenders. An unrepresented taxpayer will unwittingly tick the wrong box on the form supplied by the life assurance company, which can have significant tax consequences – as Mr Joost Lobler (in the recent case) found out. When a partial surrender is taken from the bond there are 2 ways this can be done:-

  • Cashing in a number of whole policy segments – no tax
  • Cashing in a slice of the whole investment – significant tax

In Mr Lobler’s case £560.000 tax on £66,000 profit!! That’s a tax rate of just over 800%. Mr Lobler appealed against the injustice and although the First Tier Tribunal upheld HMRCs’ view on the grounds that Mr Lobler could have taken financial advice before making any withdrawal, thankfully common sense prevailed at the Upper Tribunal on the grounds that the charge was “wholly disproportionate” to the gain made.

The 2017 Finance Act attempted to fix this problem by giving taxpayers the right to a review for any such bond encashments where they believe too much tax has been paid over recent years but unfortunately the legislation is complex and unrepresented taxpayers are probably oblivious to all of this.

The lesson here is to make sure that proper tax or financial advice is taken before encashing or surrendering any bond investment to ensure that you don’t fall into any of these traps that can end up hitting the pocket!

And if you have enchased an investment bond (wholly or partially) in recent years which triggered a significant tax charge and you would like a review – you know who to call!

This concludes the second part of our “Mini Personal Finance Jamboree”. If you have any questions in relation to the matters mentioned and would like some advice on planning, please contact me on 020 8551 7200.

Article by

Paul Dell


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