Techzone

Clients who surrender part of their investment bond and find that they have created a large and unrealistic tax bill for themselves may be able to rewind the clock. Anyone in this situation will be able to apply to HMRC within two years to have the gain recalculated on a ‘just and reasonable’ basis from next April. While this may give bond owners peace of mind, prevention is always better than cure and there's no substitute for advice.

Many bonds are set up with multiple identical segments for flexibility on encashment, allowing each segment to be cashed in independently. But a large surrender can also be taken from all the segments – which may lead to an unexpected chargeable gain which bears no resemblance to the actual investment performance.

This has led to a series of recent court cases with very similar circumstances. All invested in an offshore bond. All withdrew money across all segments in their bond relatively soon after investment. None of them took advice on how to make the withdrawal.

Unusually the court cases focused not so much on the interpretation of legislation but rather the fairness of the result.

An end to unrealistic tax charges

HMRC have been seeking a solution which puts an end to unfair and unrealistic tax charges. Various options were considered, but ultimately they decided not to tinker with the chargeable event rules.

Instead they will consider applications on a case by case basis applying ‘rectification’ where the gain is wholly disproportionate to the actual investment returns. This avenue is not open to those who have simply surrendered their bond and underestimated the tax they will have to pay.

In each of these cases, had the withdrawal been taken as full surrender of individual segments, the tax due would have been a fraction of the final bill.

There are two options when withdrawing money from an investment bond with hugely different tax results. It's important to understand the differences and to give clear instructions when requesting withdrawals. Choosing the wrong one or relying on a provider's default option can prove disastrous.

1. With a partial surrender, money is taken equally across all the segments. A chargeable event will occur at the end of the policy year if the amount withdrawn exceeds the cumulative 5% allowance.
2. Surrender any number of segments in full. This will be an immediate chargeable event, with any gain relating directly to the investment growth.

Adviser best practice – a safety net

The ABI have issued ‘best practice’ guidelines which providers should adopt when dealing with requests for part surrenders. The guidelines suggest that providers intervene before the point of no return and the payment is issued. They should give customers sufficient information to allow them to make an informed decision and recommend that they seek advice.

Some providers supply the customer with a calculation of the expected gain in each scenario to help with their decision making. As more bond providers adopt this best practice, the number of cases slipping through the net and requiring rectification should be minimal.

But creating the lowest possible chargeable gain won’t be right for everyone. Some clients may want to extract gains from their offshore bond which fall within their combined personal allowance, savings rate band and personal savings allowance. Here achieving the largest possible tax free gain may be preferable. This is why advice is so important.

Accidents can happen

Where a partial surrender results in a large gain, this can be wiped out by surrendering the whole policy before the end of the policy year. If the policy anniversary has already passed, the situation can still be put right if the full surrender can be made in the same tax year as the as the partial surrender gain.

These actions are not ideal as it means the remaining bond has to be surrendered in full to correct the problem caused by the earlier part surrender. The new ability for bond owners to apply to HMRC for rectification at least means what is left in the bond can remain invested and gains on them deferred until a time of their choosing.

A pension contribution to the rescue

Even pre-planned surrenders can unwittingly lead to additional tax charges. It's easy to overlook the impact chargeable gains may have on allowances and benefits a client receives.

Entitlement to personal income allowances (including the personal savings allowance) and child benefit can be affected by a chargeable gain. And it's the full gain before top slicing which is used to test eligibility.

Making a pension contribution could be the cure for those faced with unexpected tax charges.

The gross pension contribution reduces the ‘adjusted net income' used to determine whether clients will face the high income child benefit tax charge used to recoup child benefit from families where one parent earns more than £50,000. The same definition of income is used to determine entitlement to the personal allowance for those with income over £100,000. And the Personal Savings Allowance is reduced from £1,000 to £500 when a basic rate taxpayer becomes a higher rate taxpayer and to nothing for additional rate taxpayers. Again a pension contribution could help here.

Paying a pension contribution can retrieve these allowances if the chargeable gain has pushed income above these key thresholds.

A gross pension contribution also has the effect of extending the tax bands. This could wipe out any higher rate tax if the top sliced gain doesn't exceed the increased higher rate threshold.

A contribution made to an occupational pension scheme which operates a gross pay arrangement will have a similar effect. Although the contribution won't extent the basic rate tax band, the contribution will reduce the individual's gross pay before tax.

Summary

It's easy for a prospective client to recognise the need for advice when they have a cheque in hand ready to invest. Faced with a variety of tax wrappers and seemingly infinite number of funds, the choices can be daunting. Turning to an adviser who can make sense of it all is the logical solution.

What about when they want some of their money back? Is the need for advice quite so obvious at this point?