Will this be a 'chargeable event' and is there any way of avoiding it?

qwerty155

I have had a personal investment plan with Scottish Widows for about 11 years. I originally invested approximately £42k and it's now worth approx £59k, so it's earned £17k.

I was hoping to withdraw the whole investment so I could use this for a mortgage deposit. My current basic PAYE salary is now £54k pa, does that mean I'm likely to be liable for 40% tax on the whole £17k? I've only relatively recently started earning in the higher tax band - is this just bad timing and I've lost out for not thinking about this earlier or is there a way round this? Or is it best to speak to an financial advisor who can go a bit more indepth with the options?
Many thanks in advance.

Daliah

If your investment isn't in a tax wrapper, the gain will almost certainly be subject to Capital Gains Tax. 

Mothman

Is it not an onshore investment bond? In which case basic rate tax will already have been deemed to have been deducted and top slicing relief may also be available.

Linton

qwerty155 said:

I have had a personal investment plan with Scottish Widows for about 11 years. I originally invested approximately £42k and it's now worth approx £59k, so it's earned £17k.

I was hoping to withdraw the whole investment so I could use this for a mortgage deposit. My current basic PAYE salary is now £54k pa, does that mean I'm likely to be liable for 40% tax on the whole £17k? I've only relatively recently started earning in the higher tax band - is this just bad timing and I've lost out for not thinking about this earlier or is there a way round this? Or is it best to speak to an financial advisor who can go a bit more indepth with the options?
Many thanks in advance.

Assuming this is an investmenht bond (which it would seem to be see: https://www.scottishwidows.co.uk/existingcustomers/investments/pip/) and that you have not withdrawn or added any money......

 - Gains on large withdrawals are taxed under Income tax in the current tax year, not CGT.
 - As Mothman says basic rate tax is assumed to have been paid.  So the basic rules do mean that you will be charged 20% higher rate tax on the £17K.

However if the effect of the one off income tax is to change your income tax band then "top slicing" can be used whereby the gain is divided by the number of years ie £17K/11=£1.55K.  If that figure added to your income does not change your tax band then you do not have to pay the higher rate tax.

In ytour case you say you have a salary of £54K which would appear to mean that you cannot use top slicing.  However aren't you making pension contributions which could reduce your tax band?   Also will you have you been paid £54K for the whole of the current tax year?    Either way if you can put yourself more that £1.55K below the higher rate tax band over the year then you should not have to pay any tax on the PIP withdrawal.  What about an extra pension contribution if necessary?

Tax on investment bonds is complex.  Hopefully I have got it right but it would be nice if someone could corroborate my analysis.

masonic

Yes, it seems very likely it's an investment bond, so I've removed my previous post which would be relevant to an investment fund.

I think there is a possible workaround to reduce the taxation if you can avoid encashing the whole bond or whole policy segments. You have a 5% per year withdrawal allowance that would see that sum not subject to any further taxation while the policy remains active. This can be rolled forward as a cumulative tax deferred allowance, so it would allow you to take 55% of the original investment amount without paying any more tax now. The remainder you took out would need to be taxed at 20% as outlined by Linton above. The tax on the 55% would be deferred until the remainder of the bond was withdrawn, which could be done when you are in a more favourable tax position. However, this will only help if the amount you take is less than £40k (and the closer to the allowance of £23k the better), because it removes the link between the chargeable gain amount and the investment performance, so all of the excess withdrawal is taxed, not just the gain on it.

See for example https://connect.avivab2b.co.uk/adviser/articles/tech-centre/pensions-planning/pre-retirement-accumulation/investment-bond-taxation-partial-withdrawal-or-full-segment-encashment/

Malthusian

Even leaving aside that you need the money, the ongoing tax within the bond may mean that it is better to bite the bullet.

If growth within the bond was 5% a year, at 20% the internal tax would be £590 a year and rising. (In practice I think the actual rate of tax that life companies pay on income and gains tends to be just under 20%, but I forget by how much.)

20% tax on a chargeable gain of £17k is £3,400.

Between the dividend, CGT and ISA allowances, there is no reason even a higher rate taxpayer should be paying tax on an investment of £59,000 in isolation.

So unless you were going to move into the basic rate band within the next few years, making it an easy choice to wait until then and save the tax - and that would be unusual for someone of house-buying age - getting out now is likely to be better in the long run than waiting for some long-distant point in the future when you might be able to cash the bond free of tax in your hands.

And if you're buying a house with the proceeds, you are moving the funds into a completely tax-free investment (no tax on imputed rent and no CGT on primary residences).

Linton

Yes, but the amount of money at stake is 20% of £17K=£3.4K.

Assuming the £54K income is all in this tax year and is after any regular pension contributions and the OP withdraws all the PIP:

A one-off pension contribution of £6K would give tax relief of £4K X 0.4 + £2KX0.2 =  £2K.  Add in the £3.4K tax saved from the Investment Bond gives a tax save of £5.4K which pays for 90% of the pension contribution.  Looks like a pretty good deal.

PS The OP would need to work out the exact numbers.

Mothman

If you have a spouse who is a basic rate tax payer it may be possible to assign the bond to them to surrender to save some tax. However as Linton has already mentioned the taxation of investment bonds is complex and so it may be worth taking proffesional tax advice depending on the cost.

qwerty155

Thanks all for your really helpful answers, especailly to Linton.
I had not thought about my pension contribution being deducted from my taxable income, which does keep me in the basic tax band. So the top slicing option is available to me as far as I understand, which is great news! Will investigate futher to make sure I've got this right.
Thanks again to everyone for taking the time to reply, it's much appreciated.

Dazed_and_C0nfused

A lot of pension contributions don't reduce your taxable income.

They add to your basic rate band. 

In a lot of scenarios it can be the same outcome but you really need to be sure and understand the consequences before committing yourself one way or another.

Net pay contributions do reduce taxable income i.e. salary £55k less 10% net pay contribution = £49.5k taxable income

Relief at source contributions leave your taxable pay as £55k but you have a larger basic rate band.

Linton

Dazed_and_C0nfused said:

A lot of pension contributions don't reduce your taxable income.

They add to your basic rate band. 

In a lot of scenarios it can be the same outcome but you really need to be sure and understand the consequences before committing yourself one way or another.

Net pay contributions do reduce taxable income i.e. salary £55k less 10% net pay contribution = £49.5k taxable income

Relief at source contributions leave your taxable pay as £55k but you have a larger basic rate band.

Thanks I was hoping that someone would check my theory. Investment bond taxation is complex.

However I believe in this case where top slicing would be required to avoid HR tax the net effect should be the same as the criterion is "Top slicing relief is a remedy for this (an IB withdrawal taxed at a higher rate). It only applies when the full gain takes an individual into the higher rate or additional rate bracket. The relief is an amount deducted from the final tax liability, and is based on the difference between the tax on the full gain and the 'average' gain (or 'sliced' gain)." (see https://techzone.abrdn.com/public/investment/Taxation-of-bonds).

So ISTM with a suitably sized pension payment HR tax on the withdrawal should be avoidable under all circumstances, even Salary Sacrifice.

I would be interested in understanding circumstances where this may not apply.