Can someone explain top slicing?

Langtang

We have just received a letter regarding one of my late mother-in-laws investment policies. It states that due to the size of the gain there may be tax due. They say this can potentially be overcome by “top slicing” but not sure how this works.
MIL only had state pension as income, had never worked, and with no investments in her name in the last few years of her life (other than this policy, and a few held jointly with her late husband)
The gain is £42.5k, with a potential tax Bill of £8.5k

HHarry

As I understand it top-slicing is where you sell off just a part of your holding to lock in some benefit.
So you might have 100 shares that have tripled in value, so you sell half and bank the profit in case they fall in value.
Or you have 100 shares that have gained in value and  selling them all in one go would mean having to pay Capital Gains tax.  So you sell just enough to ensure that your profit from the shares is less than the CGT allowance for that year.

Linton

Top slicing is a term used in the taxation of "Investment Bonds" which were popular before S&S ISAs were available.  They are unusual in that the capital gains are taxed under Income Tax rather than CGT.    They have the tax advantage that Basic Rate Tax is assumed to have been paid by the fund manager so they only incure Higher or Additional Rate Tax.

The problem is that when you cash them in it could raise your income for that year to fall within the higher rate tax band.  This was accepted as being unfair so that in this situation Top Slicing is allowed whereby the gain made is spread  over the period during which you held the Investment Bond and you are only charged Higher Rate/Additional Rate tax if this raises your tax band to Higher Rate/Additional Rate in the year you cash in the Bond.

I have missed outr a bit of detail as it is not necessary for understanding the basics.

PS I guess the the "potential" tax bill is stated because the management company has no idea of your MILs tax situation. 

lindabea

Top-slicing has nothing to do with the selling of shares.  It is a method of mitigating the tax liability when surrendering insurance investment bonds or as in your case, on the death of the policy holder.  It is a very complicated calculation and I'm still learning, but basically, it only applies if your total gain pushes you above the basic rate threshold as basic rate tax has already been paid by the insurance company.  If the gain pushes you above the basic rate (including all your other income  for the tax year ), than you can apply the top-slicing; in simple terms, you take the total gain (including any previous surrenders) and divide that by the number of years the policy had been held.  There's a lot more to it than this, but to help you further, I found this link useful. 
  

dunstonh

<over simplification warning and assumes onshore bond and not an offshore bond>
if there have been no withdrawals on the bond during its history, then you take the gain of the bond and divide it by the complete number of policy years it has been in existence.  That gives you the slice.  If you add the slice to her income in the tax year it was surrendered then there will only be further tax to pay if the figure takes her into the higher rate band.   if she remains in basic rate or lower, then no further tax is payable.
If there have been withdrawals then further steps may be required.
Top slicing is not applied to the personal savings tax allowance.  With the figures you mention, its likely a reduction to £500 will occur with that.  That won't be a problem unless she earned more than £500 in interest.

Chargeable gain certificates have to state the figures before top slicing relief as they dont know if the policy qualifies for it or not (she could have been a higher rate tax payer for example). 

HHarry

Apologies for giving a wrong explanation.  Hope you get it sorted out.

Langtang

Thanks very much for all the replies, they are very much appreciated. 

Am I right in assuming that since the bond hadn’t been touched since it’s inception in 1999, that the gain could be split over all the intervening years? 

There are 4 more bonds that were in joint names with her (late) husband, which were taken out at the same time. They all have similar gains, so can I assume that there will be similar letters to follow from those companies too? And will top slicing apply to those?

Also, with the bonds that were in joint names, with the money going to the last persons estate (MIL) that there will be a similar tax bill on each?

once again, thank you for taking the time to respond.