Capital Gains Tax on With Profit Bonds

Primrose

Can somebody please clarify this for me. I've read today that following the Budget, Capital Gains Tax at 40% will still be payable on "Investment Bonds run by Life Assurers when they're cashed in, if you're a higher rate tax payer. I'm not, but my OH are I hold a Prudential With Profits Bond and wonder if we will have to pay Gapital Gains Tax on this when we cash it in, or are With Profits bonds not the same as Investment Bonds? Is the only way of avoiding tax to cash it in in small tranches, each one below the annual Capital Gains Allowance? As it's a jointly owned bond, will we both be able to cash in tranches equivalent to our individual annual Capital Gains Allowances? I believe there is also a facility to withdraw a certain percentage of a With Profit Bond every year tax free. Can any body please explain how this works. Thanks.

dunstonh

Capital Gains Tax at 40% will still be payable on "Investment Bonds run by Life Assurers when they're cashed in

That is wrong. There is no capital gains tax on investment bonds.

I'm not, but my OH are I hold a Prudential With Profits Bond and wonder if we will have to pay Gapital Gains Tax on this when we cash it in, or are With Profits bonds not the same as Investment Bonds?

Investment bond is the tax wrapper. With profits is a fund that can be utilised within the tax wrapper. Same as pensions and ISAs are just tax wrappers but you can place many thousands of different investments within them.

Investment bond gains are liable for income tax not capital gains. In very simple terms, when you create a chargeable event (like surrender) you take the gain of the investment and divide it by the complete number of years held. If its joint you divide that in two. You then add that figure to your income. If it takes you into higher rate then you have a higher rate liaiblity on half (or both if you are both taken into higher rate). If you are not taken into higher rate then there is no further liability for tax.

Surrendering segments over the years is a way to avoid or reduce tax if higher rate is a problem.

I believe there is also a facility to withdraw a certain percentage of a With Profit Bond every year tax free.

5% is allowed per year (or rolled up so if you didnt take it in year one you could take 10% in year 2. However, this is not exactly tax free. It gives no immediate tax liaiblity and the withdrawal is not added to your income for tax purposes. That is what can make it tax efficient for some. However, the withdrawals are deferred until you create a chargeable gain (like surrender) and then they are put back into the value again.

Primrose

Thanks for that explanation. So, to check that I understand you correctly, if, as two lower tax rate payers, we were to withdraw around £14,000 from our With Profits Bond every year (to be able to use up our annual ISA allowance) until it was exhausted, and that for each of us the £7,000 withdrawal does not take our income over the Lower Tax Band threshold, there would no further tax for us to pay ?

Apart from the mechanics of it, is there any advantage in doing this? If we eventually takeincome from Pensions and other savings we could possibly slip into the higher rate band at some point, so presumably using up our ISA allowance every year by withdrawing from the Bond would make sense?

dunstonh

if, as two lower tax rate payers, we were to withdraw around £14,000 from our With Profits Bond every year (to be able to use up our annual ISA allowance) until it was exhausted, and that for each of us the £7,000 withdrawal does not take our income over the Lower Tax Band threshold, there would no further tax for us to pay ?

Correct.

Apart from the mechanics of it, is there any advantage in doing this?

Absolutely yes. The ISAs get the 10% tax credit and fixed interest/bond funds within the ISA can claim the tax back. Plus, there is no corporation tax on the ISA which there is on the bond. The transaction taking an annual withdrawal to feed an ISA is very common.

so presumably using up our ISA allowance every year by withdrawing from the Bond would make sense?

Yes. ISAs do not exist for income tax purposes. So you should use the ISA each and every year if you can.

Primrose

Many thanks for your helpful clarification.