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Your top five queries about chargeable events

So far this year, members of Canada Life’s ican technical team have answered over 3,000 queries from advisers on a wide variety of subjects. One of the main topics of conversation has been chargeable events, and below are the top five most common queries.

No. 1. Entitlement to personal allowances

The growth in the value of an investment bond and the gain realised on full encashment can be considerable if the bond has been running for many years.

There is a common misconception that it is the top-sliced gain which is added to a person’s income to determine their entitlement to personal allowances and any means-tested benefits.

But even though HMRC allows the gain to be spread over the complete number of years the bond has been in force to calculate the tax liability, they will treat the whole gain as income in the tax year in which the event occurred. This means that if a large gain is realised the person might lose some or all of their personal allowance.

For example, a bond that has been running for 10 complete years realises a gain of £80,000 on full encashment in the 2017/18 tax year, when the client’s earned income is £29,500 plus savings income of £500. When the whole gain is added to their income it takes them over the £100,000 threshold by £10,000. This means their personal allowance is reduced to £6,500 (£11,500 – £10,000/2). The gain can then be top-sliced to calculate the tax liability (20% x £80,000 = £16,000) but remember that the client will have an extra 20% tax liability on £5,000 of their earned income. Also, despite the fact that all the gain will be assessed at the basic rate, the client will have their personal savings allowance reduced to £500.

No.2. 5% allowance and top-ups

Calculating the tax-deferred allowance can be difficult when there have been top-ups.

Each year, 5% of the premium paid in that year plus 5% of any premium paid in any previous year can be withdrawn without an immediate liability to income tax. This is known as the ‘tax-deferred withdrawal’ facility. Any allowance not used can be carried forward to future years.

As well as the 5% allowance there is an overall maximum limit. Once 100% of the cumulative allowance has been used then any further withdrawals, regardless of the amount, are considered a chargeable event.

For example, consider a bond commenced on 1 January 2010 with a premium of £100,000. Top-ups were applied on 3 March 2015 (£50,000) and 2 February 2016 (£100,000). In September 2017, the client wants to withdraw all the tax-deferred allowance, having previously made no withdrawals.  The client will have a cumulative tax-deferred allowance of £57,500 (£100,000 x 5% x 8 years + £50,000 x 5% x 3 years + £100,000 x 5% x 2 years).

Remember that, going forward, the client will only have 12 years’ tax-deferred allowance left on the original amount and so on for the top-ups.

No. 3. Multiple gains

It is not uncommon for a client to generate more than one chargeable gain in a tax year, for example, if they surrender all their investments across all companies.

Where the total gains put the client into a higher tax band, basic into higher or higher into additional, top-slicing relief may be available. It‘s therefore important to understand the chargeable event rules where a client has more than one chargeable gain in any tax year.

First of all, calculate the top-sliced gain for each bond, then add the total top-sliced gains to the client’s income for the tax year and calculate the tax liability. Once the tax liability has been calculated it needs to be allocated pro rata across the bonds being surrendered.

Let’s look at an example:

Ben is surrendering three investment bonds and his earnings for the current tax year are £2,000 below the higher rate tax band. There are no other gains during the tax year.

  Bond A Bond B Bond C
Type of bond UK UK International
Original investment £100,000 £70,000 £250,000

Withdrawals

taken as 5% each year

None £35,000 None
Surrender value £120,000 £75,000 £270,000
Gain £20,000 £40,000 £20,000
Years held 5 years 10 years 4 years

The tax payable under each bond is calculated as follows:

1: Calculate the top-sliced gain for each bond.

  • Bond A has a top-sliced gain of £20,000 ÷ 5 = £4,000.
  • Bond B has a top-sliced gain of £40,000 ÷ 10 = £4,000.

Bond C has a top-sliced gain of £20,000 ÷ 4 = £5,000.

2: Add the total top-sliced gains to the client’s income for the tax-year and calculate the tax liability.

  • The total top-sliced gain for the tax-year is £4,000 + £4,000 + £5,000 = £13,000.
  • The whole gain under the international bond is chargeable to 20% as there is no tax paid within the bond, therefore the liability is £20,000 x 20% = £4,000.

The UK bonds are already deemed to have paid basic rate tax.

  • For higher rate tax, £2,000 of the gain is covered by the remainder of the basic rate tax band. Therefore £11,000 of the top-sliced gain is chargeable at the higher rate of 20%.

Additional tax payable on the top slice is therefore £11,000 x 20% = £2,200.

3: Pro-rata the total tax liability across the different bonds being surrendered.

  • Total liability x (gain under bond ÷ total gains for tax-year) x number of years held.

Bond A

£2,200 x (£4,000 ÷ £13,000) x 5 = £3,385

Bond B

£2,200 x (£4,000 ÷ £13,000) x 10 = £6,769

Bond C

£2,200 x (£5,000 ÷ £13,000) x 4 = £3,385

In addition to the higher rate tax liability of £13,539, the international bond also has a basic rate tax liability of £4,000.

Ben has a tax liability of £17,539 against the chargeable gains. There will be an additional income tax liability if the policy gains before top-slicing when added to his income exceed £100,000 as his personal allowance will reduce accordingly. In addition, his entitlement to the personal savings allowance will reduce to £500.

No. 4. Student loans and chargeable gains

Most children heading to higher education need to supplement their finances with a student loan.  Where that child could also potentially benefit from an investment bond, consideration needs to be given to the exit strategy, if that occurs when the child is working.

The child may have to make additional student loan repayments if they receive savings income of more than £2,000 a year. Savings income includes interest on stocks, shares or savings.

Chargeable gains are treated as savings income so, where a gain is realised and assessed on the child, they could be asked to make loan repayments of 9% of the gain.

No. 5. Segment surrender or partial withdrawals

Which way is best will depend on the client’s circumstances at the point they require the money. When deciding which option is suitable there are a number of factors to take into consideration but, as a general rule, if the amount required is less than the 5% tax-deferred allowance, use that.

If the amount required is much higher than the 5% tax-deferred allowance, or regular withdrawals have used it up, segment surrenders would normally result in the lowest gain. A combination of partial withdrawals and segment surrenders could, however, trigger an even lower gain.

But remember chargeable gains in respect of partial withdrawals are calculated at the end of the policy year, whereas gains on segment surrenders are calculated on the actual date of the event.

If these dates fall in different tax years, the tax bill could be payable earlier depending on which way the money is withdrawn. So, if the client has fluctuating income, the timing of the chargeable event may be crucial.

Also remember that if segments are surrendered, any accumulated and future 5% withdrawals relating to the surrendered segments will be lost.

Canada Life offers a range of wealth management solutions, including retirement income planning, estate planning and investment solutions from a choice of jurisdictions, including the UK, Isle of Man and Republic of Ireland.

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