Pension contributions and top slicing Investment bonds (onshore)

A look at how making pension contributions in the same tax year as releasing a chargeable gain on a bond can mitigate part or all of any further tax payable.

Key Points

Any chargeable gains from the full or partial surrender of investment bonds are assessed for income tax purposes.

Any gain falling into the basic rate band should not normally result in any further tax payable, but where it falls into the higher or additional rate, there will be further tax to pay (an additional 20% or 25%).

Where a chargeable gain falls into two tax bands, it is possible to top slice the gain.

Making pension contributions can mitigate all or part of any additional tax due on a chargeable gain by extending the basic rate band to cover all or part of the top sliced gain.


Reduce income tax on investment bond gains

HOW ARE INVESTMENT BONDS TAXED?

For individuals liable to tax under the chargeable event regime:

  • Any gain is treated as having paid basic rate tax
  • Non-taxpayers cannot reclaim this tax credit
  • For higher rate taxpayers there is a further 20% tax due
  • For additional rate taxpayers there is a further 25% tax due

For individuals, where any chargeable gain takes them into higher or additional rates of tax, it is possible to top slice the gain.

HOW CAN MAKING A PENSION CONTRIBUTION POTENTIALLY REDUCE ANY INCOME TAX PAYABLE?

  • Any pension contributions paid net are grossed up within the scheme, giving basic rate tax relief
  • The basic rate tax band is expanded by the size of the gross pension contribution
  • If the gross pension contribution extends the basic rate band to cover all or part of the top sliced gain on the bond, the amount of tax paid can be reduced or eliminated
  • The pension contribution needs to be made in the same tax year in which the tax payable on the gain from the investment bond occurs.

Example - Brian

Brian

  • Is a basic rate taxpayer
  • Has income of £50,000 from employment
  • Is looking to surrender his UK investment bond
  • He has held the bond 10 years and is showing a gain of £50,000
  • The top-sliced gain is £5,000

If Brian makes a net pension contribution of £4,000, he can:

  • Receive a grossed up pension contribution of £5,000
  • Keep his adjusted net income within the basic rate tax band (including value of top sliced gain from bond)
  • Surrender his bond without paying any further tax on the chargeable gain
  • Build up further retirement benefits

Brian’s net pension contribution of £4,000 has resulted in:

  • £1,000 - tax relief in his pension
  • £10,000 - saved in tax on the surrender of the bond

EFFECTIVE TAX SAVING AND RELIEF IN PENSION:

£11,000


Planning considerations

PENSION CONTRIBUTIONS CAN HELP CLIENTS:

  • Make full use of the annual allowance
  • Utilise any carry forward of unused allowances
  • Build up retirement benefits

PENSION TAX PLANNING CAN HELP CLIENTS:

  • Keep their total income within the basic rate of tax
  • Reduce or eliminate the tax payable on gains from investment bonds
  • Reduce the tax due on other investment income or gains within the tax year

This briefing note is also available as a PDF

This document is based on Canada Life’s understanding of applicable UK tax legislation and current HM Revenue & Custom’s practice, as at February 2019 and could be subject to change in the future. It is provided for professional advisers only. Any recommendations are the adviser’s sole responsibility.

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