Using personal allowance with investment bond gain?

dunroving

[Asking this question on behalf of a close friend who is unfamiliar with Forum posting and money issues give her the heebie-jeebies]

I posted a couple of years ago about taxation of withdrawals from an onshore investment bond with Aegon. From that thread, and my own additional research online, I learned that for each year after the start of the investment bond, 5% of the original investment amount can be withdrawn without causing a chargeable event. I also learned that this "5% rule" is cumulative/carried forward - so if no withdrawals are made until Year 10, then in year 10, 50% of the initial investment amount can be withdrawn without causing a chargeable event.

So far, so good. My friend took some small withdrawals that fell below the annual cumulative 5% amount. Then, last year she withdrew an amount that took her above the cumulative 5% amount. Without getting into the actual numbers, the additional income she took (above the cumulative 5% amount) fell within her personal income tax allowance - so if any tax was potentially due, we thought she'd be OK. For the sake of discussion, let's say she gets £7,000 from her state pension and during the year she took no additional income, other than £5,000 she took from the investment bond above the cumulative 5% amount.

Here's where things get a bit complicated. She received a chargeable event certificate from Aegon (with copy sent to HMRC) stating the amount of the gain (£5,000) and "Amount of tax treated as paid" (£1,000). This caused her to panic about needing to pay HMRC £1,000. I assured her that *to the best of my limited knowledge* she wouldn't have to pay HMRC anything. Her income currently is limited to ca. £7,000 from state pension, and she doesn't file a self-assessment tax return. The additional £5,000 from the investment bond still was below her personal income tax allowance. But I suggested she ask her accountant (she used to run a small business as a sole trader). His response was (a) she can't count the bond income against her personal income tax allowance, so (b) she will have to pay the £1,000 to HMRC.

I have two questions:

(1) Why can't she count this income against her personal income tax allowance? I can't find anything anywhere that suggests this is correct - indeed, Zurich's booklet lists personal allowance and personal savings allowance can be used to offset investment bond income..
(2) As she is on such a low income, would she need to pay tax on larger amounts - for example, if she had withdrawn £15,000 above the 5% rule? I've read several information booklets from investment bond providers (Zurich, Aberdeen, for example), and keep finding statements about onshore investment bonds along the lines of:

"Onshore bonds are taxed as the top part of income, so after dividend income. They benefit from a non-reclaimable 20% tax credit, reflecting the fact that the life companywill have paid corporation tax on the funds. This tax credit will satisfy the liability for non and basic rate taxpayers. Further tax is only payable if the gain when added to all other income in the tax year falls in the higher rate band and above." (from Aberdeen's information sheet; Zurich has an almost identical statement)

- This appears to indicate that because she would normally be a basic rate taxpayer, she can make larger withdrawals ostensibly tax-free, as long as they don't push her into the higher rate income tax band.

Sorry for the long description, but I thought it would save the "20 questions" follow-up for additional information. ;-) Thanks for any help you can give me/her.

dunroving

As a follow-up, for further info, below is an excerpt of the email her accountant sent her:

"Unfortunately this chargeable event is considered outside of your other income when calculating tax payable.

Chargeable events do not benefit from the use of an annual exempt amount or a personal allowance – the tax free bracket that you usually fall into – and as a result are always subject to tax.

For non-tax payers such as yourself the rate is 20% of the gain– and as such it looks as though Aegon have calculated this correctly."

- my friend interpreted this as meaning she needs to pay HMRC 20% of the excess gain, but based on the information I posted above, surely this 20% has already been paid by Aegon, and she'd only need to pay HMRC 20% if she falls into the higher rate tax band?

[Deleted User]

It’s a long post but, in short: 

1) personal allowances are not available against such gains - never have been. However the deemed tax paid is non-recoverable. As it is treated as paid, no further liability is due and there is NO requirement to pay £1000. If she remains a basic rate taxpayer that’s the end of the story!

2) if the chargeable gain takes the recipient into higher rate tax a claim for ‘top slicing relief ‘ can be made. In short, the gain is divided by the number of holding years and, if the resultant figure would have meant that the recipient was a basic rate taxpayer, the claim is made for the whole gain to be liable to basic rate tax only. From what you say it is very unlikely that the chargeable gain will be sufficient to worry about this. But, if we had some figures we could be more certain.

https://www.mandg.com/pru/adviser/en-gb/insights-events/insights-library/top-slicing-relief-facts

[Deleted User]

dunroving said:

As a follow-up, for further info, below is an excerpt of the email her accountant sent her:

"Unfortunately this chargeable event is considered outside of your other income when calculating tax payable.

Chargeable events do not benefit from the use of an annual exempt amount or a personal allowance – the tax free bracket that you usually fall into – and as a result are always subject to tax.

For non-tax payers such as yourself the rate is 20% of the gain– and as such it looks as though Aegon have calculated this correctly."

- my friend interpreted this as meaning she needs to pay HMRC 20% of the excess gain, but based on the information I posted above, surely this 20% has already been paid by Aegon, and she'd only need to pay HMRC 20% if she falls into the higher rate tax band?

Our posts crossed. Your final comment is correct - no tax to pay whatsoever if she remains a basic rate taxpayer as it is ‘deemed paid’. The accountant is also correct.

dunroving

[Deleted User] said:

It’s a long post but, in short: 

1) personal allowances are not available against such gains - never have been. However the deemed tax paid is non-recoverable. As it is treated as paid, no further liability is due and there is NO requirement to pay £1000. If she remains a basic rate taxpayer that’s the end of the story!

2) if the chargeable gain takes the recipient into higher rate tax a claim for ‘top slicing relief ‘ can be made. In short, the gain is divided by the number of holding years and, if the resultant figure would have meant that the recipient was a basic rate taxpayer, the claim is made for the whole gain to be liable to basic rate tax only. From what you say it is very unlikely that the chargeable gain will be sufficient to worry about this. But, if we had some figures we could be more certain.

https://www.mandg.com/pru/adviser/en-gb/insights-events/insights-library/top-slicing-relief-facts

Thank you for your clear reply.

Re: your (1) above, that makes complete sense, as anybody who might want to use the personal allowance (a person on very low income) wouldn't be liable for tax on a chargeable excess event anyway (with the caveat that this is conditional on her remaining within basic rate tax band on total income). I already understood also that she couldn't use any unused personal tax allowance to claw back any tax already paid by Aegon.

Re: your (2) above, I came across the top-slicing relief thing while doing my earlier research, but I didn't want to muddy the waters by adding it to an already-long post. Unless she cashes in the whole bond in a one-er (which she has absolutely no intention of doing), there's no way she'd end up in the higher-rate tax band. 

dunroving

purdyoaten2 said:

dunroving said:

As a follow-up, for further info, below is an excerpt of the email her accountant sent her:

"Unfortunately this chargeable event is considered outside of your other income when calculating tax payable.

Chargeable events do not benefit from the use of an annual exempt amount or a personal allowance – the tax free bracket that you usually fall into – and as a result are always subject to tax.

For non-tax payers such as yourself the rate is 20% of the gain– and as such it looks as though Aegon have calculated this correctly."

- my friend interpreted this as meaning she needs to pay HMRC 20% of the excess gain, but based on the information I posted above, surely this 20% has already been paid by Aegon, and she'd only need to pay HMRC 20% if she falls into the higher rate tax band?

Our posts crossed. Your final comment is correct - no tax to pay whatsoever if she remains a basic rate taxpayer as it is ‘deemed paid’. The accountant is also correct.

Thanks also for this clarification. I think the accountant's error was in assuming she understood that the 20% had already been paid by Aegon, and that no further tax is due. He knew perfectly well that she has no income above £7k state pension, so could have given her a clear reassurance that she did not need to pay the tax amount stated in the chargeable event certificate - as you did in this reply. ;-) I didn't want to post the content of her email to him in my initial query, but she essentially asked him if she had to pay the amount stated and he could easily have said, "already been paid - no further tax is due". It caused her a lot of unnecessary worry for quite a while.