Full vs part segment surrender when withdrawing funds from a bond

Deciding how to withdraw funds from a bond when the whole bond is not being encashed.

The ‘5% rule’ for insurance bonds is widely used and enjoyed by individuals and trustees.

Part surrenders of up to 5% of accumulated premiums can be taken without any immediate tax charge. Where there has been a part surrender, a calculation must be made at the end of the insurance year to see whether a gain has arisen and if so its amount. A gain will then only arise if, the part surrender value(s) received exceeds the available 5% allowance. Any allowance not used can be carried forward for use in subsequent years.

An investor can therefore withdraw 5% of a single premium investment each year for 20 years without a chargeable event occurring. The maximum allowance is 100% of any premium. The allowance will not accrue after 20 insurance years have elapsed but any unused allowance can be carried forward beyond that point (4% for 25 years perhaps).

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. To generate an exact amount of proceeds it may be necessary to encash some segments and then take a part surrender from across the remaining segments.

This is best illustrated with an example:

In summary, where a withdrawal is required which significantly exceeds 5% limits then it may be the case that an encashment of some segments followed by a part surrender from across the remaining segments (where necessary) will produce a smaller gain. The following points are however relevant.

• Each case must be judged on its own merits.
  
  
• The smallest gain figure is not always desirable. For example, a low rate taxpayer with an onshore bond might prefer crystallising a larger gain if it gives rise to no tax implications at that time.
  
  
• The calculations must be performed prior to any withdrawal being made. Once a surrender or part surrender of a policy has been validly made, it cannot be reversed.
  
  
• 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.
  
  
• Tax legislation allows a person who has made a part surrender giving rise to a gain 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 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.