Investment bonds are liable to income tax
Single premium investment bonds are taxed under the chargeable event legislation, which means chargeable gains are assessed to income tax rather than capital gains tax (CGT). This can result in gains being taxed at rates up to 45% losing almost half the ‘profit’. UK based/onshore investment bonds provide the bondholder with a tax credit of 20% of the gain compensating for the corporation tax suffered within the insurance wrapper. This results in a personal income tax liable to higher (further 20%) and additional rates (further 25%) only.
There are numerous reliefs available for chargeable event gains but the one we will focus on today is top slicing relief. This relief allows any gain to be divided by the complete years made over to provide an aggregate or annualised gain figure. This aggregate gain is used to calculate the tax on the full gain as if your client had made it each year owned to help avoid paying higher rates of income tax than they would normally pay.
For more information on the top slicing relief calculation visit our chargeable events hub. Quick reference guide 5 covers the calculation in full.
Pension contributions extend income tax bands
Although relief at source pension contributions receive immediate tax relief of 20% within a UK registered pension scheme, higher and additional rate relief is provided by extending income tax bands. This works by extending the basic rate and higher rate band by an amount equivalent to the gross (after 20% relief at source) pension contribution. For example, if £8,000 was paid into a relief at source scheme, £10,000 would be credited to the scheme and the basic rate band would be extended from £37,700 to £47,700. This allows more income to be taxed at 20% providing the additional 20% relief for higher rate taxpayers. The same concept exists for higher rate band i.e. the amount that can be earned before 45% is payable.
Basic planning can help to avoid a tax bill on a bond gain or provide a net £0 bill
Using the concepts of top slicing relief and extending income tax bands, simple planning can help your client avoid paying a higher rate of tax on a chargeable event gain. Your client must be eligible to make a relief at source pension contribution (and have sufficient annual allowance remaining) and have sufficient funds to make one. The proceeds from the bond withdrawal could of course provide some or all of the money.
We will look at two examples, the first an onshore bond gain and a simple way to avoid paying further income tax on the gain. The second, achieving a net tax bill of £0 on a bond gain for a higher rate taxpayer.
The examples use 2023/24 allowances and bands:
- Personal allowance = £12,570
- Basic rate band = £37,700