Taking money from a bond: individual policy surrender or partial surrender?

Canada Life investment bonds offer the facility to divide the premium into a series of identical policies.

This means that clients wishing to withdraw part of their investment have a choice as to how to take it, either by taking a partial surrender or by surrendering individual policies.

Which way is best will depend on the client’s circumstances at the time. Before deciding which option is suitable there are a number of factors to take into consideration.

Points to consider

One of the main benefits of an investment bond is tax deferral. Part surrenders of up to 5% of the total premiums paid, can be withdrawn without any immediate personal liability to tax. Any unused 5% allowance can be carried forward to future years.

Where the cumulative 5% allowance is exceeded a chargeable gain will occur. So, where a client withdraws a significant partial surrender a substantial chargeable gain could occur as there is no correlation between the gain and the growth on the bond.

Any withdrawal will be taken into account on the eventual full surrender or maturity of an investment bond or the death of the last surviving life assured.

The timing of the chargeable event also needs to be considered. Chargeable gains in respect of withdrawals are calculated at the end of the policy year, whereas gains on policy surrenders are calculated on the actual date of the event.

These dates may fall into different tax years, meaning that the tax bill is payable earlier. Also, if the client has fluctuating income the timing of the chargeable event may be crucial.

The entitlement to future 5% withdrawals also needs to be considered. If a full policy surrender is used the encashment of policies means that the 5% withdrawal will not be available on those policies in future.

For example, if a client starts with 100 individual policies of £1,000 each and surrenders 20 individual policies, their 5% tax deferred withdrawal allowance will immediately drop from £5,000 each year to £4,000.

Also, any 5% withdrawal allowance carried forward and not used in respect of previous years for the policies surrendered will be lost.

So which is best, a partial surrender or policy surrender?

It is truly ‘horses for courses’ and depends on the client’s circumstances. As a general rule, if the amount required is less than the 5% withdrawal allowance, use that.

If the amount required is much higher than the 5% withdrawal allowance, or regular withdrawals have used it up, policy surrenders would normally be best.

And whilst not wishing to complicate matters further, in some cases the lowest chargeable gain figure can be achieved by taking a combination of withdrawal and policy surrenders.

Do not think that just because the client is a basic rate taxpayer that the chargeable gain can just be ignored. It could be the case that when the top-slice gain is added to the client’s other taxable income, the total will exceed the higher rate threshold.

Examples

a. 5% withdrawal covers the amount required
Bond commenced 01/05/2010
Premium £100,000
Policies 100 at £1,000 each
Withdrawals to date nil
Withdrawal required £40,000 on 01/11/19
Current surrender value £160,000 (£1,600 each policy)
Partial withdrawal
5% allowance 50% (including current policy year)
Allowance £50,000
Partial surrender £40,000
Chargeable gain nil
Date of chargeable event not applicable
Individual policy surrender
Amount required £40,000
Number of policies encashed 25
Gain for each policy £600
Chargeable gain £15,000
Date of chargeable event 01/11/19
Top slice £1,667
Tax year 2019/20
5% allowance now £3,750 a year
 
 
b. Large partial surrender
Bond commenced 01/05/2018
Premium £100,000
Policies 100 at £1,000 each
Withdrawals to date nil
Partial surrender required £72,600 on 01/11/19
Current surrender value £110,000 (£1,100 each policy)
Partial withdrawal
5% allowance 10% (including current policy year)
Allowance £10,000
Partial surrender £72,600
Chargeable gain £62,600
Date of chargeable event 30/04/20
Top slice £31,300
Tax year 2020/21
Individual policy surrender
Amount required £72,600
Number of policies encashed 66
Gain for each policy £100
Chargeable gain £6,600
Date of chargeable event 01/11/19
Top slice £6,600
Tax year 2019/20
5% allowance reduces from £5,000 to £1,700 a year
c. 5% withdrawal used up
Bond commenced 01/05/2015
Premium £100,000
Policies 100 at £1,000 each
Withdrawals to date Year 1 & 2 £5,000 (taken in July each year)
Year 3 £6,000 taken in July (1,000 chargeable gain 30/04/18)
Year 4 & 5 £5,000 (taken in July each year)
Partial surrender required £38,000 on 01/11/19
Current surrender value £95,000 (£950 each policy)
Partial withdrawal
5% allowance 0% (fully used)
Allowance nil
Amount required £38,000
Chargeable gain £38,000
Date of chargeable event 30/04/20
Top-slice £19,000
Tax year 2020/21
Individual policy surrender
Amount required £38,000
Number of policies encashed 40
Gain per policy £200*
Chargeable gain £8,000
Date of chargeable event 01/11/19
Top slice £2,000
Tax year 2019/20
5% allowance reduces from £5,000 to £3,000 a year

* This gain arises because the calculation on a policy surrender takes into account the previous withdrawals on each policy.

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 March 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.

This website is for UK professional advisers only and is not approved for use by private customers.

Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

Canada Life International Limited and CLI Institutional Limited are Isle of Man registered companies authorised and regulated by the Isle of Man Financial Services Authority.

Canada Life International Assurance (Ireland) DAC is authorised and regulated by the Central Bank of Ireland.

Stonehaven UK Limited and MGM Advantage Life Limited, trading as Canada Life, are subsidiaries of The Canada Life Group (U.K.) Limited. Stonehaven UK Ltd is authorised and regulated by the Financial Conduct Authority. MGM Advantage Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority.