1 : 8 - Bonds

Question 1

How are life assurance bonds treated for tax?

Answer 1

The life office that has issued the life assurance bonds has already been subject to tax at the basic rate.

This means that fund income that is not already taxed in the UK, such as interest or property income, is taxed at the fund level at 20%.

Question 2

How much can an investor withdraw without paying any immediate tax?

Answer 2

Up to 5% each year of the amount paid into the bond

Question 3

Is this allowance cumulative?

Answer 3

Yes - and any unused portion of the limit can be carried forward to the future.

Question 4

What is the maximum limit on the carry-over allowance?

Answer 4

The maximum limit to this carry-over allowance is 100% of the amount paid into the bond.

Question 5

How does this change for Higher-rate taxpayers

Answer 5

Higher-rate taxpayers are liable for tax above the basic rate, but they can defer their withdrawals of up to 5%, for example, to the time when they retire and may have a lower tax position.

Question 6

What kind of events during the life of the bond can trigger a potential liability?

Answer 6

• death
• transfer of legal ownership
• withdrawal of more than 5% of the annual allowance
• cashing in part or full value of the bond.

Question 7

What is the advantage of Offshore Bonds?

Answer 7

These products offer growth on their funds that is largely free from any tax within the fund (though not on withdrawal).

Question 8

Broadly, a life assurance plan will be qualifying if the following apply:

(6)

Answer 8

• The policy term is ten years or more.
• Premiums are payable annually or more frequently.
• It is subject to an annual premium limit of £3,600 payable in a 12-month period.
• The sum assured is not less than 75% of the premiums payable over the term.
• Premiums paid in any one year are not more than twice those paid in any other year.
• Premiums paid in any one year are not more than 1/8th of premiums paid over the term

Question 9

What tax do Life assurance policies have to pay?

What is the implication of this?

Answer 9

They all have tax to pay within the fund, which can restrict growth

Question 10

What tax applies to Life assurance policies?

Answer 10

The actual nature of UK tax, taken as corporation tax, can be very complex, but the net result is that funds are assumed to have paid tax at 20%.

Question 11

What is the appeal of endowments?

Answer 11

They are always sold as qualifying policies and benefit from being free of income tax or CGT in the hands of the policyholder after ten years, or three quarters of the term if that is sooner (ie, a 12-year policy qualifies after nine years).

Question 12

What’s the difference between qualifying policies, and non-qualifying policies?

Answer 12

Unlike qualifying policies, non-qualifying policies are liable to additional tax. This additional tax liability is an income tax liability not a CGT liability.

Question 13

What is the mnemonic for memorising chargeable events?

Answer 13

DAMES

D - Death
A - Assignment for money/money's wrth 
M - Maturity 
E - Excess withdrawal
S - Surrender

Question 14

What happens when a chargeable event occurs?

Answer 14

A chargeable gain is calculated.

Question 15

How much is an individual investor in a SPLAB entitled to withdraw from the original investment per annum, with no immediate tax liability?

Answer 15

5%

Question 16

In what way are the 5% available withdrawals cumulative?

Answer 16

If they are not used for a number of years, an investor may be able to make a large withdrawal and not have an immediate tax liability – provided they do not withdraw more than 100% of the original invested amount.

Question 17

EG:

Harry invested £50,000 in a SPLAB just over nine years ago. He has never made any withdrawals. As he is now in the tenth policy year, he is allowed ten 5% withdrawals without an immediate tax liability. He is therefore able to withdraw up to £25,000 on this basis.

Answer 17

As we can see from the list of chargeable events, a partial surrender over the permitted limit will result in an immediate tax liability. So, if Harry withdrew £35,000 rather than the £25,000 he is entitled to, it would be a chargeable event and a chargeable gain would have to be calculated. Whether Harry has any additional tax to pay would depend largely on his tax status at the time of the chargeable event.

Question 18

What does SPLAB stand for?

Answer 18

Single Premium Life Assurance Bond

Question 19

What is the benefit of ‘Top slicing’ a SPLAB?

Answer 19

Top slicing can reduce the amount of tax liability if none of the taxable income, before the profit slice, would have been subject to tax above the basic rate.

Question 20

How is ‘Top slicing’ relief calculated to help reduce the tax liability for a SPLAB?

Answer 20

To calculate this, the excess is divided by the number of complete years that the SPLAB has been held (or since the last chargeable event, if more recent). The amount of the profit slice is added to the holder’s taxable income. If any part of the profit slice falls into the higher-rate (and the additional-rate, where applicable) tax band, it is taxable at the difference between higher/additional rate of income tax and the basic rate of income tax.

For offshore policies, there is no deduction for basic-rate income tax.

The total tax due is then calculated by multiplying this amount of tax on the profit slice by the number of complete policy years that the bond has been held (or by the number of complete policy years since the last chargeable event, if more recent).

Question 21

EG:

Harry has withdrawn £35,000, which is £10,000 above the amount allowed. He has made this gain over nine years, so he is into his tenth policy year. When top-slicing a partial surrender, we are able to use part-years. So: £10,000/10 = £1,000 slice.

Answer 21

This is then added to Harry’s taxable income (ie, after allowances) for that tax year.

If we firstly assume he has taxable income of £30,000:

• £30,000 + £1,000 = £31,000
• This is below the basic-rate band for 2018–19 of £34,500
• Therefore, Harry has no additional tax to pay.

If we then assume he has taxable income of £37,000:

• £37,000 + £1,000 = £38,000
• This is £3,500 over the basic-rate band for 2018–19 of £34,500
• This £1,000 is taxed at 20% = £200
• We then need to multiply by the number of part-years the plan has been running
• £200 x 10 = £2,000
• Harry will have an additional tax liability of £2,000.

Question 22

What would the tax rate be if Harry had a taxable income of £160,000?

Answer 22

25% (not 20%).

Question 23

EG:

Let’s assume that Harry has never taken any withdrawals, but instead chooses to totally surrender the SPLAB in the tenth policy year. The surrender value is £62,000 (based on his investment of £50,000). When top-slicing a full surrender, we use full policy years in the top-slicing calculation. So:

• (£62,000 – £50,000)/9 = £1,333.33.

This is then, again, added to Harry’s taxable income for that tax year.

Answer 23

If we again assume he has taxable income of £30,000:

• £30,000 + £1,333.33 = £31,333.33
• This is still below the basic-rate band for 2018–19 of £34,500
• Therefore Harry has no additional tax to pay.
Financial Protection

If we then assume he has taxable income of £37,000:

• £37,000 + £1,333.33 = £38,333.33
• This is £3,833.33 over the basic-rate band for 2018–19 of £34,500
• This £1,333 is taxed at 20% = £266.67
• We then need to multiply by the number of full years the plan has been running
• £266.67 x 9 = £2,400, which is Harry’s tax liability on the surrender.

Question 24

EG:

Let’s assume that Harry took a £25,000 withdrawal, as he was entitled to, in the tenth policy year. He then took no further withdrawals, but chose to surrender the plan fully in July 2015 after 18 years, with the policy value sitting at £55,000.

What is his chargeable gain?

Answer 24

(£55,000 (policy value) + £25,000 (untaxed withdrawals)) – £50,000 (original investment)

= £30,000

This is then, again, added to Harry’s taxable income for that tax year.

Question 25

What is the drawback to using a SPLAB as an actual investment?

Answer 25

SPLABs pay more tax within the fund, and, in isolation, that would appear a good reason for using the more tax-efficient unit trusts and OEICs, as the fund should grow more quickly.

Question 26

What is the advantage to using a SPLAB as an actual investment?

Answer 26

Withdrawals from SPLABs do not count as income: they can therefore be very tax-efficient for higher-rate taxpayers.

Question 27

Can non-qualifying policies be written in trust?

Answer 27

As with qualifying policies, non-qualifying policies can be written in trust to help avoid an IHT liability.