UK investment bonds: taxation planning ideas

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. 

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. 

Option 1 – withdrawal across all the segment 

Option 2 - encash segments 

On 30/6/22 the value per segment is £1,300. Therefore, proceeds of £39,000 will require 30 segments to be encashed. 

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. 

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 

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

“Underlying arrangements in relation to a bond may be complex. A bond may comprise a collection of policies and the tax consequences flowing from withdrawals from it may be quite different depending on whether the withdrawal takes the form of a part surrender across a number of policies, or whether one or more policies from the collection are fully surrendered. Ultimately, it is the policyholder’s responsibility to understand the implications of making these choices.”

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."

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.

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.