INVESTMENT BONDS AND PENSIONS – A LONGSTANDING RELATIONSHIP

Whilst paying tax is an inevitable consequence of a well-managed investment strategy, the ability to reduce any tax liability at the same time as boosting pension savings is a good illustration of how different tax wrappers can be combined to give an advantageous tax outcome. This article sets out a case study to demonstrate how this can work in practice.  

Last autumn’s Budget announcement that pensions will be in scope for inheritance tax purposes from 6 April 2027 has led to a lot of talk about the starting of new or updating of existing gifting strategies with investment bonds being seen as a key part of this. However, pensions and investment bonds are old ‘bed fellows’ when it comes to reducing potential tax burdens as the following example shows.

Case Study: Sandra

• Sandra has taxable income of £55,000.
• She also has an onshore investment bond with a gain of £45,000 and she has held the bond for ten years.
• If Sandra surrenders the bond, she will pay tax on the gain at 40% but will receive a 20% tax credit in respect of the tax deducted within the bond.
• The tax payable is therefore £45,000 x 20% = £9,000. As the sliced gain of £4,500 is fully within the higher rate tax bracket there is no top slicing relief.

The planning opportunity

• If Sandra makes a personal contribution to her personal pension of £8,000, she will extend her basic rate threshold by the gross contribution amount of £10,000 to £60,270 (£50,270 basic rate limit + £10,000 gross pension contribution).
• The sliced gain is now fully within the basic rate tax bracket and so no additional tax is payable on the gain.
• In effect, it has cost Sandra £8,000 to save tax of £9,000, but she also saves an additional £946 as £4,730 of her other taxable income is now in the basic rather than higher rate tax bracket.
• Furthermore, a £10,000 gross contribution has been added to her pension pot.
• This would also work for offshore bond gains except that there would be a 20% liability on the full gain as no tax would have been deducted within the bond.

If you have any questions, please feel free to contact the Technical Services team.

All information is based on our understanding and interpretation of applicable law and regulation.