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Investment bonds – tax efficient withdrawals

Introduction

This briefing sets out the options of taking tax efficient withdrawals from Investment Bonds. 

Core considerations  

  • Partial surrender withdrawals using the 5% tax deferred allowance could be used when an investor requires regular withdrawals.

  • For larger “one-off” withdrawals, a chargeable event gain comparison of a partial surrender using the cumulative 5% tax deferred allowance and full surrender of segments options need to be compared. 

  • The potential income tax liability of the withdrawal will depend on whether the bond is Onshore or Offshore. 
  • ‘Washing out’ gains if there is no income tax liability so that the chargeable event gain is lower on final surrender. 
      

Contents

Surrender Options

A bond is a tax deferred investment, so no tax is paid by an individual on the gains until a chargeable event occurs, which may happen when a surrender from the bond is taken.  

Surrenders from a bond can be arranged by either: 

1. Partial surrender – using the 5% tax deferred allowance; or  
2. Full surrender of segments – this is same as fully surrendering ‘mini’ policies; or 
3. a combination of the two options. 
 

Partial Surrender

A bond’s tax-deferred withdrawal allowance permits an investor to partially surrender 5% of the capital across the individual policies each policy year without incurring an immediate liability to income tax. This is known as a tax deferred allowance.  

The allowance in respect of each premium paid, ceases to accrue once 20 policy years have elapsed from the policy year in which the premium was paid.  Any unused allowance from a previous policy year, carries over to the next and future policy years, until these have been used. 

Therefore, partial surrenders across all policies could be considered if the investor wishes to receive regular withdrawals or one-off part surrenders. 

Any excess partial surrender above the cumulative 5% tax deferred allowance will be a chargeable event. 

From 31 December 2012, any initial and ongoing adviser charges that may apply would count towards the individual’s tax deferred allowance.
 

Partial Surrender example

On 01/01/2013, an individual invested £100,000 in a bond (100 segments). The annual 5% tax deferred allowance is £5,000 for 20 years. Each policy year, partial surrender withdrawals of £4,000 have been taken (totalling £40,000 up to and including 1 January 2023). Therefore, there were no previous partial surrender chargeable event excess/gains.

On 01/09/2023, the value of the life assurance bond was £150,000. A withdrawal of £75,000 is required. 

The bond is in its 11th policy year and so the cumulative 5% tax deferred allowance is £55,000 (£100,000 x 5% x 11). 

The total previous partial surrenders are £40,000 (no previous excess chargeable gains). 

The unused cumulative 5% tax deferred allowance is £15,000. 

If the £75,000 is taken as a partial surrender across the bond, it will trigger a chargeable event gain of £60,000.

 

Full Surrender of bond (segments)

An investment bond is a segmented policy – and is made up of mini-policies, otherwise referred to as segments or clusters. This means it is possible to fully surrender one or more segments rather than all of the bond. 

The chargeable event gain on a full surrender of the bond (segments) is calculated as follows: 

(surrender value + the total of all previous part surrenders) minus (total premiums paid + previous excess gains) 

If there is a full surrender of individual segments, rather than all segments within the bond, the amounts used in the calculation need to be proportioned so that they are only in respect of the segments being fully surrendered. 
 

Full surrender example

On 01/01/2013, an individual invested £100,000 in a bond (100 segments). The annual 5% tax deferred allowance is £5,000 for 20 years. Each policy year, partial surrender withdrawals of £4,000 have been taken (totalling £40,000 up to and including 1 January 2023). Therefore, there were no previous partial surrender chargeable event excess/gains.

On 01/09/2023, the value of the life assurance bond was £150,000. A withdrawal of £75,000 is required.

The value of each segment is £1,500 (£150,000 / 100).

To realise £75,000, then 50 segments (£75,000 / 1,500) must be fully surrendered.

The chargeable event gain on 50 segments would be:

(£75,000 + £20,000) – (£50,000 + £0) = £45,000.  


In the second example the gain is £15,000 less than withdrawing the £75,000 across the plan (as shown in the first example). But this may be the right option depending on the individual circumstances of the investor. 

Even though a withdrawal option may result in a higher chargeable event gain, it might be an opportunity to ‘wash out’ the gain if there is no income tax liability now, so that the chargeable event gain is lower on final surrender. 
 

Partial Surrender or Full Surrender considerations

When considering which encashment option to use, the amount of chargeable event gain as well as the following points, should be considered. 

Partial Surrender (one off part surrender or the 5% withdrawal facility)  

  • The chargeable event date it is the last day of the policy year in which the partial surrender exceeds the 5% allowance, so the chargeable event date could be in the next tax year following the actual part surrender itself.  
  • The number of years for top slicing is the number of years from the date of any previous chargeable event (if no previous chargeable then its date of commencement) to the end of the relevant policy year. 
  • For Offshore Bonds issued before 6/4/2013, the number of years for top-slicing is back to the start date of the bond, unless: 
      • it has been varied to increase benefits e.g. exercise a policy option, 
      • there has been an assignment by way of gift or consideration. 

Full Surrender (of segments)

  • The chargeable event date is the actual date of the full surrender. 
  • The number of years for top slicing is the number of complete years from the date of commencement to the date of surrender. 
  • If the individual surrenders one or more segments, the 5% allowance will proportion down accordingly, therefore any future part surrenders should be reviewed to ensure that the 5% tax deferred allowance is not exceeded. 
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