BOND WITHDRAWALS – CALCULATING CHARGEABLE GAINS
The Transact Onshore and Offshore Bonds are both life assurance policies and whilst the investments linked to the bond might generate income and capital gains, investors are only required to report and pay tax in relation to these investments if a chargeable gain arises on a chargeable event (although deductions for tax do arise inside the onshore bond in respect of the life companies’ tax liabilities).
Typically, chargeable events arise in relation to surrendering of segments, withdrawals exceeding the 5% tax deferred withdrawal limit or on death of the last life assured. When these events occur, we issue a chargeable event certificate containing the relevant information in relation to the gain so that it can be reported by the policyholder. One of the key features of investment bonds is that they provide a means to defer the payment of tax on income and gains and so understanding the triggers for these events and how to calculate the gains provides the opportunity to maximise these features.
Partial withdrawals
Investment bonds are considered medium to long-term investments, but they are often set up with the intention to provide regular payments. Typically, the regular payments make use of the 5% tax deferred withdrawal mechanism using ‘partial withdrawals’ which means that there is no need for the policyholder to report or pay tax on the withdrawal at that time. For any year in which the 5% tax deferred withdrawal limit is not used, or not taken in full, the excess rolls over into the following year’s allowance. However, if a partial withdrawal exceeds the 5% tax deferred limit, the excess is considered a gain and is reported to the policyholder at the end of the policy year.
Example 1: Assume a premium of £250,000 and regular partial withdrawals of £10,000 per annum for the first three years and a partial withdrawal of £30,000 in the fourth year.
| Year | 5% tax deferred allowance available | Unused tax deferred from previous years | Total 5% tax deferred limit | Withdrawal amount | Gain |
|---|---|---|---|---|---|
| 1 | £12,500 | £0 | £12,500 | £10,000 | £0 |
| 2 | £12,500 | £2,500 | £15,000 | £10,000 | £0 |
| 3 | £12,500 | £5,000 | £17,500 | £10,000 | £0 |
| 4 | £12,500 | £7,500 | £20,000 | £30,000 | £10,000 |
Note, the reported ‘gain’ reflects only the withdrawal amount and the difference from the 5% tax-deferred limit, not changes in the policy’s actual value. It is also important to remember that adviser and investment manager fees are treated as partial withdrawals for the purposes of the tax deferred limit (although this may not apply if the bond was established prior to 31 December 2012).
Segment surrenders
As an alternative to the ‘partial withdrawal’ method, it is also possible to surrender one or more segments. Our bonds now default to 1,000 segments allowing for more fine tuning with the withdrawal amount. When surrendering segments the chargeable gain will take into account the increase in value of the policy, along with any partial withdrawals and previous gains arising in relation to partial withdrawals. So, from the above example, how does the calculation of the chargeable gain change when using the segment surrender approach to withdraw £30,000?
Example 2: Using the same assumptions as example 1, except that the £30,000 withdrawal is taken via the surrender of segments. The bond has 1,000 segments. We will assume that the bond’s value has increased to £275,000.
Step 1 – calculate the number of segments that need to be surrendered
Value of Bond Value of each segment Withdrawal Amount Segments Required
£275,000 £275 £30,000 109
Step 2 – Calculate the gain per segment
| Premiums | Premium per segment | Value of each segment | Previous withdrawals per segment | Previous gains per segment | Total gain per segment |
|---|---|---|---|---|---|
| £250,000 | £250 | £275 | £30 | £0 | £55 |
Value of each segment less premium per segment plus previous withdrawals less previous gains.
Step 3 – Multiply the total gain per segment by the number of segments required
- £55 x 109 = £5,995
Note that the actual withdrawal value for 109 segments is £29,975 (£275 x 109). The difference would usually be made up with a small partial withdrawal from the remaining segments. The alternative would be to surrender 110 segments. This would give a withdrawal value of £30,250 and a total chargeable gain of £6,050.
So, for the withdrawal of £30,000, a partial withdrawal would give rise to a gain of £10,000 and for segments surrender, £5,995. This would make the segment surrender route look more attractive, although whether it is the best approach from a tax perspective could depend on a whole range of factors, not least the policyholder tax position for the tax year in question. Another difference between these approaches that is often overlooked is that the effective date for tax purposes will be the date of a segment surrender. Withdrawals that exceed the 5% tax deferred allowance have a tax date linked to the policy year end, which could fall in the subsequent tax year.
All information is based on our understanding and interpretation of applicable law and regulation which is subject to change. Tax treatment depends on individual client circumstances and may change in the future.