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Our most common queries on chargeable events no.2 & 3


Continuing our focus on the most common questions around chargeable events, we look at the two evergreen queries below. 


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Each year, 5% of the premium paid in that year plus 5% of any premium paid in any previous year can be withdrawn without an immediate liability to income tax.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 of 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.

 

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