Having considered fund and investor taxation in relation to the most suitable choice of retail investment wrapper in the light (you may recall) of the recent “Dear CEO” FSA letter to the heads of wealth management businesses, let’s look this week at encashment/ realisation strategies.
By implementing appropriate planning, most advisers will be well aware that tax can be minimised on encashment and withdrawal of benefits from a collective or a bond.
With a UK or offshore collective, there is a no gain/ no loss disposal when there is a transfer between spouses/ civil partners living together.
This means it may be possible to avoid capital gains tax by transferring a collective to a spouse or civil partner so that the transferee spouse can use their annual CGT exemption or lower (than 28 per cent) CGT rate – that is, where the transferor spouse is a higher or additional-rate taxpayer and the transferee spouse is not.
With an investment bond, there could be more scope to avoid or reduce tax because (unlike a collective), an investment bond can be assigned to anybody as a gift with no chargeable event occurring and, if subsequent top-sliced gains keep the new owner within the basic-rate tax band, no tax charge will arise on a UK bond.
The 20 per cent basic rate tax charge cannot be avoided under an offshore bond except to the extent that the gain falls within the investor’s personal allowance. Top-slicing can help minimise or avoid higher/additional-rate tax.
As an alternative, the owner could manage their income down so that no higher/ additional-rate tax were due on the realised chargeable-event gain under either a UK or offshore bond, or the offshore income gain under a non-reporting fund.
Although an assignment can look extremely tax-attractive, the assignor has to accept that, once assigned, the asset no longer belongs to them.
Any attempt to use an assignee as a conduit to facilitate lower/no tax should be considered potentially doomed to failure.
If encashment is to take place gradually, that is, through a drawdown strategy, then it will be interesting to compare the relative merits and financial outcome of using the well known and administratively simple 5 per cent a year tax-deferred withdrawal facility in connection with a UK or offshore bond with the making of partial or full encashments under collective investments and using any available annual CGT exemption to take tax-free amounts to supplement income.
So how about portfolio tax management?
By using a UK or offshore investment bond as a wrapper, it is possible to switch between different investment funds with no tax charge.
However, if you switch investment funds underlying a collective (UK or offshore), you are likely to trigger a disposal for CGT with a potential CGT tax charge (an income tax charge on a non-reporting fund).
CGT can therefore be a serious tax constraint to important investment decisions in relation to collectives.
Fund of funds or manager of managers’ approaches may avoid this problem but the investor will not have control over the switch, it having, effectively, been ceded to the fund manager.
On the other hand, as indicated in an earlier article in this series, as a by-product of simple year-by-year investment management (perhaps through rebalancing a portfolio to keep within agreed asset allocation parameters) the base value of the investment can be uplifted at no tax cost through use of the annual CGT exemption.
I will continue on this theme next week by looking the subject of estate planning when considering encashment and product wrapper choice.