Tax on investment plan cash-in

Bellx15

I am just applying to effect a partial cash-in on my Prufund Investment Plan, which came to its five-year fruition last June. The Pru are asking me which way I want to divide it up, either by cashing in a number of discrete policies out of the 20 total, or by skimming a percentage off of them all.

I'm told that the chargeable income resulting is very different for the two options.

Could someone please explain to me :

1. Why I would be paying tax on the lump sum amount (not just the profits) I originally invested

2. Why the taxable amount is so different in the two cases?

Many thanks!

dunstonh

1. Why I would be paying tax on the lump sum amount (not just the profits) I originally invested

You may not do. It depends on your tax position. Basic rate tax is considered paid with these but there is no capital gains tax to pay. However, the tax position is deferred until you create a chargeable event (such as a partial surrender above 5%). The gain is then added to your income and if, after top slicing relief, you are taken into higher rate tax you will then see a tax liability. If you are still a basic rate tax payer then there is no liability.

2. Why the taxable amount is so different in the two cases?

Because one method is a partial surrender across ALL policies and the other is a full surrender across a limited number of policies. Depending on circumstances, it may not make any difference but for some it could make a lot of difference.

Investment bonds can be an effective way for higher rate taxpayers to avoid higher rate tax by deferring it until they become basic rate taxpayers. However, if the whole process means you remain a basic rate taxpayer you neither gain or lose out

Bellx15

Thank you -

so cashing in my own savings produces taxable income? That's what it seems to amount to.

But can you kindly direct me to a website where I can read up on the difference between partial and full cash-in tax implications? The difference for me is a major one, and I have no idea why. I am referring to the resultant taxable income, regardless of my personal tax position. In the one case it is £24k, and in the other just over £4k. I am cashing in £40k.

coastline

this might help..

http://www.which.co.uk/money/savings-and-investments/guides/investment-bonds/investment-bonds-tax-issues/

http://www.pruadviser.co.uk/content/support/technical_centre/taxation_uk_investment_bonds/

Bellx15

Thanks for those links.

Unfortunately, after reading through them, I can see that full and partial surrenders are treated differently, but I don't understand why.

"Maturity or surrender - if amount paid out plus any previous capital payments, exceeds total premiums paid plus total gains on previous part surrenders or part assignments. "

So if you surrender the entire bond you are taxable on the profit, not the whole sum. If you surrender a part of the bond, over 5%, you are taxable on the lot.

Why is this? Do you get to set your original investment against income at a later date?

dunstonh

Unfortunately, after reading through them, I can see that full and partial surrenders are treated differently, but I don't understand why.

Your investment bond will be made up of multiple policies. Maybe 100, maybe 250 or some other number. You dont just have one policy. SO, £40,000 invested in 100 policies is £400 per policy. By only surrendering only some of the policies in full you can reduce the tax liability by leaving the others untouched and continuing to defer the tax liability to a later time. If you do a surrender across all the policies, they will all be treated as having a gain in this year.

Some people may be creating a chargeable gain on purpose (i.e. those with varying income who want a gain in this year as they may be higher rate again next year). Others may want to limit the chargeable gain.

Why is this? Do you get to set your original investment against income at a later date?

Tax wrappers exist to allow people with different needs to utilise tax efficient ways to plan. The investment bond wrapper allows you to defer the tax until a later date. A higher rate taxpayer gets to pay no additional tax until they create a chargeable gain. At that point, they may be a basic rate taxpayer. So, the get the benefit of investing whilst being a higher rate taxpayer without having to pay higher rate tax. investment bonds also have no personal capital gains tax liability.

When investing, its not just about where you invest but which tax wrappers you use to invest in. ISAs and pensions are straightforward. However, after that, it can be close on whether you use unwrapped unit trust/OEICs (for example) or an onshore or offshore investment bond.

Linton

Bellx15 wrote: »

Thanks for those links.

Unfortunately, after reading through them, I can see that full and partial surrenders are treated differently, but I don't understand why.

"Maturity or surrender - if amount paid out plus any previous capital payments, exceeds total premiums paid plus total gains on previous part surrenders or part assignments. "

So if you surrender the entire bond you are taxable on the profit, not the whole sum. If you surrender a part of the bond, over 5%, you are taxable on the lot.

Why is this? Do you get to set your original investment against income at a later date?

Look at the detailed examples in the pru link given previously. Yes you do reduce your gain by the amount previously withdrawn above the 5% annual allowance when you surrender. This means that high withdrawals can be very tax inefficient if the overall gain is not sufficient to absorb the withdrawal above the 5% annual allowance. I guess the reason could be to prevent the tax advantages of investment bonds being used for tax evasion whilst encouraging their use for the provision of a sustainable income. Also I guess it could be argued with a withdrawal as to how much of the amount withdrawn came from the original contribution and how much from the investment gain.

Bellx15

So to put it in my simplistic terms, is it correct to say that if I do a partial withdrawal across all the constituent bonds in the plan, and then, say five years down the line, surrender what's left completely, it will be at that time that the overall gain (total income minus investment premium) is calculated to produce a figure for taxable income?

dunstonh

Bellx15 wrote: »

So to put it in my simplistic terms, is it correct to say that if I do a partial withdrawal across all the constituent bonds in the plan, and then, say five years down the line, surrender what's left completely, it will be at that time that the overall gain (total income minus investment premium) is calculated to produce a figure for taxable income?

No. If you create a chargeable event in this year then you would be potentially liable for additional tax in this year. The full surrender in later years would in turn become another chargeable event and could lead to further tax. However, the earlier chargeable events would be taken into consideration.

Only if you stick to drawing less than 5% will you avoid a chargeable event. That 5% can be carried over. So, if you have had 5 years on the investment then you could draw 25% without creating a chargeable gain. In that case, drawing across all the policies can be more effective than full surrender on some of the policies.

Do you have an IFA as this is the sort of thing an IFA would work out for you as the use of tax wrappers can be complicated? It can be costly if you get wrong as well.

Are you a higher rate taxpayer or close to being one?

Bellx15

OK - thanks. I follow all of that, except that I am still not clear on this one thing:

Since my investment premiums are not set against taxable income on the partial surrender of each bond, what happens to that investment premium? Is it taken into account later on, when the plan is fully surrendered.

Sorry if that has been explained and I missed it!

Bellx15

Excellent - thanks!

I will try to read it through more thoroughly.