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Case study: Tax-efficient ways to access onshore bonds

Rachael Griffin, Old Mutual Wealth

Anthony holds an onshore insurance bond which is currently worth £148,000. He originally invested £120,000 and has owned the bond for three years. 

His son, Alex, is at university.

Anthony worked abroad for two years but is now UK tax resident. He would like to provide Alex with extra financial support and wants to understand the options for utilising his onshore bond in the most tax-efficient way.

Potential solutions

There are several ways in which Anthony can take withdrawals from the bond. He can encash the entire onshore bond, or parts of it, to realise the proceeds and then gift them to Alex.

Partial surrender

As Anthony has owned the bond for three complete years (for two of which he was non-UK tax resident) and has taken no withdrawals, he can encash up to £18,000 without any immediate tax liability,  that is, 5 per cent of the original premium accumulated over three years. However, if he makes a partial withdrawal of £18,000, he can then only go on to encash £6,000 in year four without incurring a tax liability. This option may only be suitable if he knows he will not need flexible access to the money for a while.

Full surrender of individual policies

Anthony could fully surrender individual policies held within the bond whenever he wants. If he wants to give Alex £20,000 this year and the onshore bond has 100 policy segments (each worth £1,480),  he will need to surrender 14 policies
(14 x £1,480 = £20,720).  The tax position would be: 

  • £1,480 – £1,000 = £480 gain per policy 
  • Total tax liability is £6,720.

However, since 6 April 2013, time apportionment relief has been extended to apply to onshore bonds. This rule allows a gain to be reduced by the amount of time the person liable to the income and gains has been non-UK resident. 

The formula for time apportionment is: 

  • Gross gain x A*/B** = time apportionment relief
  • Gross gain – time apportionment relief = gain on which the tax liability is due 

(*number of days in the material interest period when the individual is not UK resident; **number of days in the policy period [the period for which the policy has run before the chargeable event occurs]).

The example below illustrates how the time apportionment relief rule can be applied. Assuming the onshore bond started after 6 April 2013 and has been in place for exactly three years, the effects are as follows:

  • £6,720 x 730 days (two years non-UK resident)/1,095 days = £4,480 time apportionment relief
  • £6,720 – £4,480 = £2,240
  • Total tax liability is £2,240.

Assignment

Another option could be for Anthony to assign individual policy segments to Alex, which Alex could choose to surrender when needed.

The calculation would be the same as in the full surrender illustration above but Alex would be unable to benefit from time apportionment relief because he has always been UK tax resident. However, as Alex is a non-taxpayer and Anthony is an additional-rate taxpayer, the saving on the tax due would be large. This is because Alex has not used his income tax personal allowance so he can receive the proceeds without any further liability to taxation.

Using a trust

Should Anthony decide to gift the whole bond to Alex, he should consider writing the policy in a discretionary trust to maintain an element of control over how the funds are distributed.  

Trustees can choose to assign segments of the fund to Alex as per the method above and, as in the assignment scenario, the segment being encashed will be subject to Alex’s marginal rate of tax, meaning there is likely to be a significant tax saving.

Additionally, writing an onshore bond policy in trust is an effective IHT planning method. After seven years, the policy will sit outside Anthony’s estate for IHT purposes. As the value of the policy falls under the nil-rate band, there will be no immediate tax charge assuming Anthony has made no other gifts.

The best way to encash a bond depends on the tax status and residential history of the policy owner. With careful financial planning, an onshore bond written in trust can allow individuals to access their money in a flexible and tax-efficient way.

Rachael Griffin is head of technical marketing at Old Mutual Wealth 

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Comments

There is one comment at the moment, we would love to hear your opinion too.

  1. Sorry Rachael but when you discuss full encashment you confuse gain with tax liability. Your example quotes a tax liability that equals the whole of the gain, although the liability is then reduced through time apportionment.

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