How does tax work on my UK bond?

Any withdrawal from your investment bond may create what is called a 'chargeable event'. When a chargeable event happens, this may create what is called a 'chargeable event gain', on which you may have to pay Income Tax. It may also affect your entitlement to personal allowance.

A liability to Income Tax at the marginal rate (the difference between the basic rate and your highest rate) may be due if a gain is made when a chargeable event occurs.

A chargeable event will happen:

• if you take cash from each of the policies in your bond to withdraw more than 5%* per policy year of the amount that you have paid into your Bond, or
• if you fully cash in your Bond or a policy within the Bond; or
• on maturity of your Bond (this does not apply to Bonds written as whole of life policies which remain in force until full and final cashing in or the life/lives assured, dies), or
• on certain assignments (transfer of legal ownership of all or part of your Bond) for money or money's worth. This can include an assignment as part of a divorce settlement. If this were to ever apply, please refer to a solicitor for further information, or
• in the event of your death.

*The 5% withdrawal allowance is cumulative, and any unused part can be carried forward to future policy years, subject to the total cumulative 5% allowance amount not exceeding 100% of the amount you have paid into your Bond.

A gain is treated as being made if you take more than the accumulated allowance in any policy year - the gain is treated as being the balance of the amount taken over the allowance.

For example:

If the 5% allowance for policy year 2 was £500 and in that policy year you take cash from each of the policies in your bond to withdraw a total of £750, a chargeable event will occur with a gain of £250.

Regular withdrawals and any adviser charges paid from a bond also count against the 5% withdrawal allowance.

We pay tax on income and capital gains accrued within our funds. HM Revenue & Customs (HMRC) treat these payments as if you have paid Capital Gains Tax and Basic Rate Income Tax. Because of this you don’t have to pay Capital Gains Tax or Basic Rate Income Tax on gains from your Bond. This does not affect your allowance for any capital gains you may make on other investments you hold. You cannot reclaim the tax we pay, even if you’re a non-tax payer.

Personal allowances and tax credits may also be reduced if a chargeable event occurs and a gain, or "profit", arises.

For more information on chargeable events please speak to your financial adviser. A financial adviser may charge you for any advice they provide.

We pay tax on any increase in the value of funds you invest in. We pay this directly to HMRC. For this reason, basic rate tax payers do not need to pay any further income tax, on any gain made when a chargeable event occurs, although higher rate (40%) and additional rate (45%) tax payers will pay income tax less basic rate.

Examples below should help explain if you will pay income tax on a chargeable event gain:

Would pay no income tax on the chargeable event gain:

If you remain a basic rate tax payer, after your gain is added to your income for the tax year, you’ll pay no income tax on the gain.

Would pay income tax on the chargeable event gain:

If you are a higher or additional rate tax payer (either 40% or 45%), before the gain is added to your income for the tax year, you will pay income tax at your highest rate less the basic rate of tax of 20%.

May or may not pay income tax on the chargeable event gain:

If you’re a basic rate tax payer before your gain is added to your income for the tax year, but would become a higher or additional rate tax payer after the gain is added. You’ll need to pay tax at your highest rate of tax (either 40% or 45%) less the basic rate tax (20%).

This may be reduced (possibly to nil) by what is known as top slicing relief (see below).

It might be that when adding a gain to your other income for the tax year, you could become a higher or additional rate tax payer.

If you are already a higher or additional rate tax payer before making a gain, you will pay tax at either 20% (higher rate less basic rate) or 25% (additional rate less basic rate) on any gain you make when a chargeable event takes place.

If the gain you make, when added to other income for the tax year, takes you into a higher or additional rate of income tax, HMRC will apply special rules called ‘top slicing relief’. This may reduce any income tax liability that has been created by the chargeable event gain.

This can be quite complicated, so to understand how this works please speak to your financial adviser or HMRC.

You can withdraw up to 5% of your initial investment (known as ‘capital payments’) each policy year without triggering a chargeable event – this is your ‘tax deferred allowance’.

You can take these payments until you’ve completely withdrawn your capital and you will not immediately pay any income tax on these payments – regardless of the rate of tax you pay.

It is important to note though that any previously withdrawn capital payments will be ‘added back’ to the final withdrawal to work out the gain the bond has made over its lifetime.

For example:

John originally invested £10,000, took 5% per year and surrendered his bond 10 years later for £20,000.

John’s gain is worked out as:

£20,000 (surrendered amount)

+

£5,000 (5% tax free cash per year for 10 years)

-

£10,000 (original investment amount)

John’s gain when he fully cashes-in his bond is £15,000.

After adding £15,000 to John’s other income for the year, he is still a basic rate payer, which means he will not pay any income tax on his gains.

Remember, when a chargeable event takes place, any gain you make, including any capital payments previously taken, may be subject to income tax.

Tax on non-UK bonds is very similar to UK bonds. The main differences are that unlike UK bonds, the funds you invest in are not taxed directly by HMRC. This is sometimes called "gross roll up".

HMRC add any gain to your other income for the year and you’ll pay basic rate, higher or additional rate on some or all of the gain.

There will be no allowance for tax paid on gains within the funds you invested in as tax will generally not have been paid (other than withholding tax on certain fund income).

Please also refer to your financial adviser for details of how top slicing relief works on bonds issued outside of the UK.

There is more than one way that you can take some of your money from your bond, while leaving the rest invested.

Your bond is divided into a series of individual identical policies (sometimes known as ‘segments’ or ‘clusters’). What you pay into your bond is spread evenly across all the policies in your bond and is used to buy investment units in each one.

By setting up your bond in this way, if you want to access some of the money, you don’t have to cash-in your whole bond; instead you can just cash in enough policies to provide you with the money you’re looking for.

Importantly if you trigger a chargeable event, only the policies which have been cashed in will be ‘tested’ to find out if a gain has been made.

Alternatively, you can take cash from each of the policies in your bond to take the money you are looking for.

For example:

You want to withdraw £1,670 and your bond has 20 policies in it you can withdraw £83.50 from each policy to achieve the total you require.

In some instances you may even be able to take a specific amount out of your bond by a combination of these two methods.

For example:

Assume that each policy is your bond is worth £500 and you need to withdraw £1,670 in total. You can cash in 3 policies (totalling £1,500) and take the other £170 you need from the remaining 17 policies (i.e. £10 per policy) in your bond.

It is very important that you understand the difference in the tax treatment of the two methods of taking some of the money from your bond. To help you understand this, we’ve created a simple guide. But we’d suggest you speak to a financial adviser first.

Please speak to a financial adviser for more information on tax. Tax rules can change and the impact of taxation (and any tax relief) depends on your circumstances.