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8 min read 27 Mar 22
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.
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. Where the beneficiary is a minor and too young to be party to a deed of assignment, then the trustees may be able to irrevocably appoint, by way of deed, one or more segments under bare trust to that minor beneficiary if the trust provisions allow that. If the trustees later encash, then the beneficiary will be the taxable person assuming the parental settlement rules do not apply (they wouldn’t apply in a will trust scenario and wouldn’t apply to a trust set up during lifetime if the settlor was not a parent e.g. grandparent. There should be no need to send the Deed of Appointment to the insurance company. Note incidentally that this type of planning may be particularly attractive when a grandparent sets up a discretionary trust for school and university costs where the intended beneficiaries will be the grandchildren. Rather than a UK bond, the investment vehicle might be an offshore bond which enjoys gross roll-up and when the chargeable event gain crystallises on the young person, then the beneficiary might have unused personal allowance, unused zero % savings rate and unused Personal Savings Allowance to help ‘mop-up’ that offshore bond gain.
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 2018, Sam invested £100,000 into a UK bond with 100 segments.
On 30 June 2022 when that investment is worth £130,000, Sam requires £39,000.
Proceeds |
£39,000 |
Cumulative 5% allowance £5,000 x 5 |
£25,000 |
Gain arising at 31/12/22 |
£14,000 |
(assuming no more withdrawals between 30/6/22 and 31/12/22) |
On 30/6/22 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 30/06/22 |
£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
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 2019, Julie invested £100,000 into a UK bond.
On 1 December 2022 she withdraws £60,000 across all the segments.
Proceeds |
£60,000 |
Cumulative 5% allowance £5,000 x 4 |
£20,000 |
Gain arising at 31/12/22 |
£40,000 |
Assume that Julie realises the consequences of the withdrawal and fully surrenders the bond prior to 6 April 2023 for £55,000. Assume full surrender occurs on 1 April 2023.
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 31/12/22 will be reportable to the policyholder before the time limit of 31/03/23.
If Julie fully surrenders on 1 April 2023, the final insurance year becomes 1 January 2022 to 1 April 2023 and the calculation of the final gain on surrender takes in all the transactions over this period, superseding the gain that arose on 31/12/22. 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 05/07/23 (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
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.
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, subject to satisfying insurable interest requirements, 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 2015 and assigned it into a discretionary trust. The lives assured are Andrew and his son. Andrew dies on 1 May 2022 and the bond continues due to the remaining life assured.
If the trustees encash the bond prior to 6 April 2023, the gain will be chargeable on Andrew (the deceased).
If the trustees encash post 5 April 2023, 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.
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.
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.
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