In last year’s Budget, the government announced that the 10 per cent starting rate of tax for savings income would be replaced with a new 0 per cent rate from 6 April 2015.
It also increased the amount of savings income the new 0 per cent rate applies to from £2,880 to £5,000. This means that anyone with a total income of less than £15,600 will not pay any tax on their savings and can register for tax-free savings.
Anyone who has earned income of less than £15,600 per year is entitled to tax free interest on their savings up to the £15,600 limit (the £10,600 personal allowance and £5,000 savings income band combined).
This has implications for offshore bondholders, allowing them to manage their tax affairs more efficiently.
Life assurance policy gains are treated as savings income within Chapter 9 of Part 4 of the Income Tax Act 2005. Gains from onshore bonds are always taxed as the highest slice of income and are therefore subject to tax at the marginal rate. Chargeable gains arising from offshore bond encashments fall within the “savings income” bracket and may, therefore, fall within the savings rate band.
Let’s assume an individual with £10,000 in annual pension income wanted to boost their retirement income by withdrawing money from an offshore bond. They decide to withdraw £10,000 a year from the bond, into which they had originally invested £100,000.
The original investment amount gives a £5000 deferred tax allowance, 5 per cent of the value of the original investment.
Therefore, the gain is calculated to be £5000 from the £10,000 withdrawal. Added to their £10,000 pension income, the individual has £15,000 taxable income and therefore falls below the £15,600 threshold.
Let’s consider another scenario. An individual inherited £500,000 14 years ago. They decided to invest the proceeds in an offshore bond. It has since grown in value and the investment is worth £1m.
The individual has two children at university and would like to help top up their income, as well as giving their partner some additional money.
The bondholder is a higher rate taxpayer earning £75,000 per year while their partner has a small income of £10,500 per year from a part time job. Both the children at university make a small income of £4,000 each year.
In order to give them some extra income, the bondholder decides to assign each of them four of the 500 policies from the bond each year. Each of the 500 policies was originally worth £1000. They are now worth £2000 each, leaving a gain of £1000 on each policy.
The bondholder’s partner will therefore have taxable income of £10,500 in salary and £4000 from the bond, creating a total of £14,500. Total income therefore falls within the £15,600 threshold.
Likewise, the bondholder’s two children will have £4000 of taxable income from the investment given to them and £4000 of salary income, meaning their £8000 income will not be taxed.
If the client had withdrawn the proceeds from the 12 policies in his own name, the tax liability would have been £4,800, as a £1000 gain will have been taken on 12 separate policies and incurred tax a 40 per cent.
As an alternative, the bondholder could have chosen to make the withdrawals as partial withdrawals across all policies within the 5 per cent tax deferred allowance. However, as the proceeds are for the benefit of the client’s partner and children, they can all take advantage of their personal allowances and the £5,000 savings income band, making this the most tax efficient solution in this situation.
Rachael Griffin is financial planning expert at Old Mutual Wealth