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UK investment bonds - tax planning ideas

Author Image The Technical Team
8 minutes read
Last updated on 22nd Mar 2021

Discover tax planning opportunities with UK investment bonds

  • An assignment by way of gift does not trigger a chargeable event
  • Beware ‘large one-off’ withdrawals
  • How to ‘escape’ a large part surrender gain triggered in error
  • The interaction of pension contributions and Investment Bond gains

What is a UK investment bond?

UK investment bonds are non income producing assets subject to a tax regime which imposes an income tax charge when a 'chargeable event' occurs and a gain arises on that. This regime is explored in our article UK Investment Bonds: taxation facts. In addition, the articles Top Slicing Relief: the facts and Top Slicing Relief: planning ideas will be of interest.

In this article we will consider tax planning opportunities with UK bonds which arise from the chargeable event legislation.

Change of ownership

An assignment by way of gift does not trigger a chargeable event, and is therefore useful for tax planning purposes since subsequent chargeable event gains are assessed on the assignee (new owner). This planning is often used by spouses / civil partners where the assignor is higher rate and the assignee is basic rate or lower. In such an event the gift would be exempt for IHT purposes. Regardless of the relationship between the parties, assignments must be outright and unconditional.

Example of assignment between two individuals

Phillip is a higher rate taxpayer who previously invested £100,000 in a UK bond. No withdrawals have been taken and when it was worth £130,000, he assigned it to Ann, his adult daughter. Ann later encashes the bond for £130,000 in a tax year when she has taxable income of £20,000

Assume the bond has been in place for six complete policy years.

Ann will benefit from top slicing relief back to inception, and therefore a top sliced gain of £5,000 (£30,000 / 6) ensures that Ann has no further tax payable.

If Phillip had encashed the bond, higher rate tax would have been due.

Note that the assignment of the bond would be a Potentially Exempt Transfer for IHT purposes.

Example of assignment from trustees to a beneficiary

Previously, the trustees of a discretionary will trust invested £200,000 in a UK bond. No withdrawals have been taken and just over eight complete policy years later, it is worth £260,000.

If the trustees encash the bond when the trustee rate is 45%, the gain will be chargeable on the trustees as follows (assume the £1,000 band has already been used).

£60,000 x 25% = £15,000.

If the trustees assigned the bond to a basic rate taxpaying beneficiary who encashed shortly afterwards, then no income tax charge would arise assuming the top sliced gain of £7,500 (£60,000 / 8) did not result in the basic rate threshold being breached. This assumes that adjusted net income does not exceed £100,000 and there is therefore no restriction to the basic personal allowance.

Where it is not appropriate to assign a bond in its entirety, then consideration may be given to assignment of individual segments or policies within the bond.

Large 'one off' withdrawals

Where cumulative 5% allowances are exceeded then the resultant gain bears no correlation to the economic performance of the bond. A significant partial withdrawal can therefore inadvertently create a chargeable event gain. In these circumstances, it may be more tax efficient to fully surrender individual segments than take a withdrawal across all segments.

Note that legislation is in place (S507A ITTOIA 2005) allowing a person who has made a part surrender or part assignment giving rise to a gain under S507 to apply to HMRC to have the gain reviewed if they consider it is wholly disproportionate. Applications must be made in writing and received within 4 years after the end of the tax year in which the gain under S507 arose. A longer period may be allowed if the officer agrees. If the officer considers that the gain is disproportionate, then the gain must be recalculated on a just and reasonable basis. The legislation came into force on 16 November 2017.

Contrasting a withdrawal across all segments versus the encashment of full segments

On 1 January 2017, Sam invested £100,000 into a UK bond with 100 segments.

On 30 June 2021 when that investment is worth £130,000, Sam requires £39,000.

Option 1 - withdrawal across all the segment

Proceeds

£39,000

Cumulative 5% allowance £5,000 x 5

£25,000

Gain arising at 31/12/21

£14,000
(assuming no more withdrawals between 30/6/21 and 31/12/21)

Option 2 - encash segments

On 30/6/21 the value per segment is £1,300. Therefore, proceeds of £39,000 will require 30 segments to be encashed.

Proceeds 30 x £1,300

£39,000

Cost 30 x £1,000

(£30,000)

Gain arising at 30/06/21

£9,000

 

If 30 segments are encashed then 70 will remain. The cost of these 70 segments is £70,000 meaning that the future 5% allowance will be reduced to £70,000 x 5% = £3,500

'Escaping' A large partial withdrawal gain

Where a partial surrender gain which arises on the last day of the insurance year is followed by a full surrender in the same tax year then the partial surrender gain is ignored and instead the proceeds are brought into the final surrender gain calculation.

Example of a part surrender gain ‘superseded’ by a full surrender in the same tax year

On 1 January 2018, Julie invested £100,000 into a UK bond.

On 1 December 2021 she withdraws £60,000 across all the segments.

Proceeds

£60,000

Cumulative 5% allowance £5,000 x 4

£20,000

Gain arising at 31/12/21

£40,000

Assume that Julie realises the consequences of the withdrawal and fully surrenders the bond prior to 6 April 2022 for £55,000. Assume full surrender occurs on 1 April 2022.

The partial surrender gain above is ignored, and instead the calculation on final surrender will be as follows

Proceeds

£55,000

Previous withdrawals

£60,000

Premium paid

(£100,000)

Gain arising when bond encashed

£15,000

In the above example, regarding chargeable event reporting by the life company, the situation will be as follows:

The gain which originally arose at 31/12/21 will be reportable to the policyholder before the time limit of 31/03/22.

If Julie fully surrenders on 1 April 2022, the final insurance year becomes 1 January 2021 to 1 April 2022 and the calculation of the final gain on surrender takes in all the transactions over this period, superseding the gain that arose on 31/12/21. This excess is no longer a chargeable event but no revised certificate is required. To be helpful, the insurer may tell Julie that the certificate issued on the final event supersedes the earlier certificate.

In the example, it is less likely that a certificate has been issued to HMRC before the insurer becomes aware of the final surrender. The time limit for reporting the excess gain to HMRC is 05/07/22 (three months from the end of the tax year in which the event occurred). So, in this example and in most cases the insurer will already know that the excess event has been superseded before it has issued the certificate.

It is important for policyholders to be fully aware of the consequences when taking a withdrawal from a bond. In IPTM1510, HMRC state the following

"...the tax consequences flowing from withdrawals from the bond may be quite different depending on whether the withdrawal takes the form of part surrender of policies across the range, or whether one or more policies among a collection are wholly surrendered. Ultimately, it is the policyholder's responsibility to understand the implications of making these choices, but the matter may be complex."

 

IPTM7330 is also of particular relevance and it is worth considering the following four paragraphs taken from this. The blunt message to policyholders is to think before a withdrawal is requested otherwise it may be too late.

"A withdrawal will be legally effected as surrenders or part surrenders of policies in accordance with the terms of the policies and the instructions of the policyholder or a person authorised to act on behalf of the policyholder, such as an IFA. Once a surrender or part surrender of a policy has been validly made, it cannot be reversed. The tax consequences must follow from the transactions which have happened, not those which in hindsight a policyholder might have preferred to have happened because they would give a lower tax bill.
 
Unless there is evidence that an insurer has acted explicitly contrary to instructions from the policyholder or a person authorised to act on his or her behalf, history cannot be rewritten to change the transactions from the form that they originally took.
 
Where the instructions to the insurer do not specify how a withdrawal from a cluster of policies is to be effected, merely requesting the withdrawal of a specified sum, then the insurer must act in accordance with the terms and conditions of the policies. This may provide for a default position, for instance effecting the withdrawal by equal part surrenders of all the policies in the cluster, or it may be silent on the point. Only if the insurer acted contrary to those terms could the transaction be revisited.
 
If an insurer receives a request for withdrawal which is not completely clear on how the withdrawal is to be effected, it should check the policyholder's intention before acting on the request."

 

Additional lives assured

Death giving rise to benefits is a chargeable event. Accordingly where a bond is taken out on a single owner single life assured basis then a tax charge might arise automatically on death. Additional lives assured can therefore create tax planning opportunities.

Example contrasting a full surrender during or after the tax year of death

Andrew took out an investment bond in 2014 and assigned it into a discretionary trust. The lives assured are Andrew and his son. Andrew dies on 1 May 2021 and the bond continues due to the remaining life assured.

If the trustees encash the bond prior to 6 April 2022, the gain will be chargeable on Andrew (the deceased).

If the trustees encash post 5 April 2022, the gain will be chargeable on the trustees.

The trustees however may consider assignment of the whole bond or specific segments to a beneficiary to utilise that individual's personal tax situation on a subsequent encashment.

Personal pension contributions

A personal pension contribution has the effect of extending the basic rate band by the gross contribution. Accordingly a contribution made in the same tax year that a chargeable event gain arises could prevent a top sliced gain from breaching the basic rate threshold. This is covered in the article Top Slicing Relief: planning ideas.

Preservation of personal allowances

As explained in the Personal Allowances article, the personal allowance is reduced by £1 for every £2 where income exceeds £100,000.

A non-income-producing investment bond can therefore be beneficial for an individual in contrast to an income producing investment which might otherwise result in an erosion of personal allowances. Note however that top slicing relief does not apply when calculating income for personal allowance purposes.

Labelled Under:
Investment bonds Tax

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