How to calculate chargeable gains tax on investment bond

Delburn

Some helpful replies from Linton, but could I just point out one thing:

Linton said

Whether you could withdraw the full £35351 is more complicated.  A worst case scenario would be if all your contributions had been made in 2017 giving you an unused tax allowance of (£22495 contribution -£2500 previously withdrawn) x 6/20 which is about £6k. Since £28k of the withdrawal is already covered one does not need to do the detailed maths to see that a full withdrawal should also be tax free.

Is this not the calculation for a partial withdrawal which leaves a small remaining investment?  For a complete surrender is the gain not just £35k -£22k + £2.5k = £15k?  In this example, clearly there is enough basic rate band either way, but maybe would be relevant in other cases. 

Doctor_Who

lindabea said:

Doctor_Who said:

I had to deal with investment bond taxation for my late Mother's estate. There were considerable gains since the bonds were bought in the 1980s, but over 30 years was available for top slicing. As Linton says, if the gain divided by number of years held, when added to your other income, doesn't push you into the higher tax band, no extra tax is due (20% tax is deemed to have been paid on the bond itself). One thing to be wary of though is that the total gain (no top slicing) is used to calculate the personal allowance. Since my Mother's gain was a solid 6 figures she lost all of her personal allowance.

Can you please explain what you mean by 'the total gain is used to calculate the personal allowance'.  Do you mean that the  personal allowance is deducted from the bond gain rather than allocating the PA against other income?  If that's the case, then all other income becomes taxable in the year the bond is cashed in ending up paying tax which you would not have otherwise paid.  .   

If your total income is above £100,000 then you start to lose the personal allowance, it is completely lost with an income above £125,140 (see here). Whilst the investment bond top-sliced gain (added to your other income) is used to determine your income tax bracket (i.e. if you have entered the higher rate band), the total gain (added to your other income) is used to calculate the withdrawal of the personal allowance. My mother had a very basic pension and income that was below the personal allowance, but when the investment bond was cashed (deemed to be the day before she died) her 'income' for that tax year was well over £125,140, hence zero personal allowance (due to top slicing she never got near the higher rate tax bracket). Probably quite a rare situation, but I thought it worth mentioning.

lindabea

dunstonh said:

My partner also has one these investment bonds with the Pru which he is considering cashing in.  He started it in 2001 by making a one-off payment of £20000.  He never made any withdrawals since it's inception.  The current cashing in value is £53000.  His income for this year is likely to be £22500 made up as follows

Pru bonds from that era are usually very good.  Nice steady eddie on the returns and before they started charging people for the guarantees.  Plus, outside of any means tested benefits (i.e. you could have £1m in one of these and still get benefits)

Your partner should give careful consideration as to whether they should cash it in as you cannot get these anymore.

They can form the safer part or a wider portfolio if necessary.

Thank you dunstonh for bringing this to our attention.  My partner is going to call the Pru (before making a final decision on whether to cash it in or not) to get some kind of T&C about this type of policy. The reason for this is that (if you recall) another forum member was asking a question recently about investment bond and made reference to it being a NEW WORLD policy, to which I was surprised to see your reply that you never heard of new world polices.  And this of course got us thinking about our own policy. As far as we know, it is an investment bond but a few years ago, I think when they merged with M&G they started calling it New World product - but we don't know what the implications are       .  

lindabea

Doctor_Who said:

lindabea said:

Doctor_Who said:

I had to deal with investment bond taxation for my late Mother's estate. There were considerable gains since the bonds were bought in the 1980s, but over 30 years was available for top slicing. As Linton says, if the gain divided by number of years held, when added to your other income, doesn't push you into the higher tax band, no extra tax is due (20% tax is deemed to have been paid on the bond itself). One thing to be wary of though is that the total gain (no top slicing) is used to calculate the personal allowance. Since my Mother's gain was a solid 6 figures she lost all of her personal allowance.

Can you please explain what you mean by 'the total gain is used to calculate the personal allowance'.  Do you mean that the  personal allowance is deducted from the bond gain rather than allocating the PA against other income?  If that's the case, then all other income becomes taxable in the year the bond is cashed in ending up paying tax which you would not have otherwise paid.  .   

If your total income is above £100,000 then you start to lose the personal allowance, it is completely lost with an income above £125,140 (see here). Whilst the investment bond top-sliced gain (added to your other income) is used to determine your income tax bracket (i.e. if you have entered the higher rate band), the total gain (added to your other income) is used to calculate the withdrawal of the personal allowance. My mother had a very basic pension and income that was below the personal allowance, but when the investment bond was cashed (deemed to be the day before she died) her 'income' for that tax year was well over £125,140, hence zero personal allowance (due to top slicing she never got near the higher rate tax bracket). Probably quite a rare situation, but I thought it worth mentioning.

Ah - OK I see what you mean.  Thank you for explaining that.  

Delburn

Doctor_Who said:

I had to deal with investment bond taxation for my late Mother's estate. There were considerable gains since the bonds were bought in the 1980s, but over 30 years was available for top slicing. As Linton says, if the gain divided by number of years held, when added to your other income, doesn't push you into the higher tax band, no extra tax is due (20% tax is deemed to have been paid on the bond itself). One thing to be wary of though is that the total gain (no top slicing) is used to calculate the personal allowance. Since my Mother's gain was a solid 6 figures she lost all of her personal allowance.

This was previously the position taken by HMRC on the personal allowance, but I believe that they were found to be mistaken:

https://www.absolutetax.co.uk/download/download/TC07103.pdf

dunstonh

The reason for this is that (if you recall) another forum member was asking a question recently about investment bond and made reference to it being a NEW WORLD policy, to which I was surprised to see your reply that you never heard of new world policies

IFAs tend to largely ignore or forget marketing names of products from decades before.   We tend to go by generic names.  (either investment bond or single premium whole of life assurance).   New world policy doesn't ring a bell. I just checked some Pru bonds from that era and the IFA version was called "Prudence Bond".  No mention of New World on anything.   However, it may be that its a Pru Salesforce version and that was their internal name.

Sometimes, old products get renamed under new software or new providers that have taken over legacy products.

 And this of course got us thinking about our own policy. As far as we know, it is an investment bond but a few years ago, I think when they merged with M&G they started calling it New World product - but we don't know what the implications are  

Pru & M&G were part of the same company but was broken up.   So, maybe New World is the "new" name that M&G are using for the legacy product.    

They key thing for tax, is that its treated as onshore insurance.

The old Pru bonds were also segmented. So, you could fully surrender segments and spread it over multiple tax years and policy years.  e.g. surrender 50% of the segments this year and only half the gain would be this year.   You can also assign them to multiple people (up to 4 typically) and spread the gain across those people.  4 people would be 25% each.  2 would be 50% each.

Doctor_Who

Delburn said:

Doctor_Who said:

I had to deal with investment bond taxation for my late Mother's estate. There were considerable gains since the bonds were bought in the 1980s, but over 30 years was available for top slicing. As Linton says, if the gain divided by number of years held, when added to your other income, doesn't push you into the higher tax band, no extra tax is due (20% tax is deemed to have been paid on the bond itself). One thing to be wary of though is that the total gain (no top slicing) is used to calculate the personal allowance. Since my Mother's gain was a solid 6 figures she lost all of her personal allowance.

This was previously the position taken by HMRC on the personal allowance, but I believe that they were found to be mistaken:

https://www.absolutetax.co.uk/download/download/TC07103.pdf

Thanks for that. All of the documentation and advice that I had at the time said that the total gain was used to calculate the personal allowance withdrawal. I guess things change over time and you only tend to have to deal with things like this once!

Doctor_Who

Delburn said:

Doctor_Who said:

I had to deal with investment bond taxation for my late Mother's estate. There were considerable gains since the bonds were bought in the 1980s, but over 30 years was available for top slicing. As Linton says, if the gain divided by number of years held, when added to your other income, doesn't push you into the higher tax band, no extra tax is due (20% tax is deemed to have been paid on the bond itself). One thing to be wary of though is that the total gain (no top slicing) is used to calculate the personal allowance. Since my Mother's gain was a solid 6 figures she lost all of her personal allowance.

This was previously the position taken by HMRC on the personal allowance, but I believe that they were found to be mistaken:

https://www.absolutetax.co.uk/download/download/TC07103.pdf

Well that was a fun read for a Monday morning! I think it is a little more complex (isn't it always).

The judge did find that the appellant was not entitled to a personal allowance because her income (including the gain) was over £122,000, see below (taken from the pdf in the link):

14. HMRC’s case was that Mrs Silver’s adjusted net income for 15/16 exceeded £122,000 so that under s 35(2) she had no personal allowance. They considered her adjusted net income to be £31,101 (her other income) plus £110,721.93 (the chargeable event gain), making £141,822 in total. We agree for the reasons given above. Therefore, we agree with HMRC that Mrs Silver was not entitled to a personal allowance in 2015/16.  

However, the document goes on to say that a 'hypothetical personal allowance' can be used when calculating the top slice relief (i.e. whether adding the top slice to other income pushes you into the higher rate tax band). It seems to be this part that the appellant was disputing with HMRC. See below (again taken from the pdf in the link):

27. This takes us back to s 23 ITA and the steps for calculating liability. Mrs Silver’s (hypothetical) income under this calculation was £31,101 plus £5,272.43 (the annual equivalent) making a total income of £36,373. (The full gain was excluded by s 536(1)(a)(i).) 

29. Mr Silver’s point was that this was a hypothetical calculation and as Mrs Silver’s hypothetical income was £36,373, s 35(2) was not applicable as the hypothetical income did not exceed £100,000. Therefore, in this hypothetical scenario, Mrs Silver was entitled to a personal allowance. 

30. We prefer Mr Silver’s interpretation of the legislation. S 536 clearly directed a hypothetical tax calculation to be carried out on certain assumptions. It would be wrong to carry out the calculation without using those assumptions consistently. Consistently applying the assumption that Mrs Silver’s income was only £36,373.43 meant that she was (in this hypothetical scenario) entitled to a personal allowance in this calculation. 

34. The result of that is that her liability to tax on the annual equivalent was nil. This is because deducting her hypothetical personal allowance of £11,000 resulted in her total hypothetical income at the end of Stage 3 being £26,373.43. That is well below the basic rate limit of £32,000 (for tax year 15/16). Therefore, the annual equivalent of £5,272.43 would have been taxable only at the basic rate; and as Mrs Silver was given credit for the basic rate, her relieved (ie hypothetical) liability would be £0. 

My take home message from this is that in this (relatively rare) situation, you will lose your personal allowance (point 14 above) and your tax liability may therefore be more than expected. Indeed, the judge says this here:

37. It can be seen that this exceeds her declared liability but that will be because she had claimed a personal allowance, to which we have found she was not entitled. 

However, you are allowed to use a 'hypothetical personal allowance' when calculating whether top slicing would put you in the higher rate tax band (point 34 above). If it does not, then there is no tax liability from the gain itself.

Congratulations if you got this far! 

Caveat: I may of course have misunderstood what the judge said.

Delburn

Doctor_Who said:

Thank you, I had not realised this distinction.  So you can use the hypothetical personal allowance to move the tax rate on the chargeable gain from the 40% to the 20% band (similarly for the 45% band), but the personal allowance is lost for all other purposes.

Doctor_Who

Delburn said:

Doctor_Who said:

Thank you, I had not realised this distinction.  So you can use the hypothetical personal allowance to move the tax rate on the chargeable gain from the 40% to the 20% band (similarly for the 45% band), but the personal allowance is lost for all other purposes.

Yes, after the 'annual equivalent' (top slice) has been added to other income (it may not move the entire amount out of the 40% tax band as it did in this case, just depends on other income and the top slice). It took me a while to understand the difference between 'hypothetical personal allowance' and 'personal allowance'. Also, there appear to be some errors with their calculations (£36,373.43 - £11,000 is not £26,373.43, as stated in point 34, however, it makes no difference to the final outcome).

They say tax doesn't have to be taxing, I think I'd disagree in the case of investment bonds!