Techzone

Options for taking withdrawals

Most offshore bonds are made up of a number of identical policy segments, typically between 100 to 1,000. Sometimes more. This structure facilitates a choice in the way cash can be taken if the whole bond is not being surrendered.

Once a client has decided how much cash they need, this can be provided by either:

• taking equal amounts of cash from each policy segment, known as a partial or part surrender, or
• the full surrender of policy segments.

The calculation of the gain under each method is very different:

Part surrender across all segments

By taking cash in this way, any gain has no link at all to investment performance; the gain is purely an artificial one.

This is because the calculation is simply: Gain = Amount withdrawn - cumulative 5% tax deferred allowance

Several important things to note here:

• Clients can take up to 5% of their original investment tax free each year until they have had their original investment back. Any unused portion carries over to the next year. If they stick within this allowance, then there will be no chargeable event and therefore no gain.
• A gain will arise if they exceed this allowance, but the test will always be at the end of a policy year, and this is when the chargeable event will happen. This could actually be in a different tax year from the one in which the cash was actually taken.
• Tax deferred amounts will eventually be included in the final calculation when the whole policy, or individual policy segments, are cashed in.

Full surrender of segments

The key point about cash being taken in this way is that any gain will be directly linked to actual investment performance. So if profits are high, gains will be high. And vice versa.

First calculate the gain on each segment:

Chargeable gain = (value of segment + previous part surrenders from segment) - (amount invested in segment + taxable gains on previous part surrenders)

The total gain will simply be the gain per segment multiplied the number of segments being surrendered.

A combination of full and part surrender

So far, our example has produced a gain of £55,000 for a part surrender and £15,000 for a full surrender.

It's possible for the gain to be reduced even further by taking cash under a combination of withdrawals.

Taxing the gain

Gains are subject to income tax, and sit on top of all other income, apart from dividends and onshore bond gains, in the tax computation.

For an offshore bond, tax could be payable at any or all of the 0%, 20%, 40% and 45% rates. ‘Top slice' relief, which broadly taxes the average gain over the whole investment period, may limit or even eliminate the amount of tax payable at the higher 40% and 45% rates

Equally, if other income is negligible or even non-existent, part of the gain may fall into the personal allowance, the savings rate band, and/or the personal savings allowance and escape income tax altogether.

BUT, how much would the tax bill have come to if James had taken his cash as a part withdrawal? The first thing to note here is that the chargeable event is now in the 2024/25  tax year, and there will also be an additional year for top slicing.

Tax planning considerations

The best solution for each client will depend on individual circumstances. For many, the smallest gain will be chosen because this will result in the lowest income tax bill, as the above example shows. But there are other factors at play which may mean a higher gain is preferred to a lower one.

Reasons for taking a lower gain

• To minimise the immediate tax bill. An extreme example; a bondholder finds they need a large withdrawal of cash for an unplanned cost early into the bond term. At this point, there is less likely to be much investment growth and so withdrawal by surrender of segments is likely to produce a relatively low gain. Conversely, there has not been much time for the 5% cumulative tax deferred allowance to build up, and so a part withdrawal may create a much larger gain
• Many individuals are likely to be lower rate taxpayers in retirement, so it makes sense to delay the tax charge until then. The same reasoning would apply where the intention is to assign the bond to a lower rate taxpayer sometime in the future
• To avoid the loss of personal allowance. For the current tax year (2024/25), a taxpayer will lose all of their personal allowance once their ‘adjusted net income' (ANI) exceeds £125,140. Broadly, ANI is total income from all sources, including the full gains (not top sliced) from investment bonds. The personal allowance is worth £5,028 pa to a higher rate taxpayer
• To avoid the child benefit tax charge. The value of child benefit is wiped out once ANI exceeds £60,000. If ANI can be kept below £50,000 including the full bond gain, this tax charge will be avoided

Reasons for taking a higher gain

• If an individual is likely to be a higher rate taxpayer in the future. This may be because they are still working and anticipating a pay rise or perhaps a large bonus.
• An increasing number of individuals can manipulate their income using pension freedoms. They could turn off their pension income in a tax year, cash in their bond and live off the proceeds, maybe escaping tax altogether if the gain falls within their tax free allowances. Gains of up to £18,570 could be taken in the current tax year completely tax free. And crystallising gains at a time when no tax will be payable can mean the eventual gain on final encashment is reduced.