No. 1: Bonds and 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 allow 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 that 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.