Why you need an Exit Strategy for Investment Bonds

Nov 5, 2018 | Savings

young businesswoman suffering from eyestrain

Don’t get caught out by a Massive Tax Bill

If you hold investment bonds or have them offshore in the Isle of Man or Ireland you may be in for a nasty tax surprise. In this post, I talk about why you need an exit strategy for your investment bonds and the reasons behind my thinking.


Why are investment bonds losing their appeal?

Investment bonds became popular before Capital Gains Tax saw a rate cut. Investment bonds which are taxed at income tax rates, (20%, 40%, 45%) were much more tax-friendly pre-2008. Now, however, CGT has dropped to 10% or 20% making unit trusts far more attractive and beneficial. As well as lower tax rates CGT is exempt on death. This is not the case for investment bonds.

Although investment bonds still have their place. Often when they are encashed punitive tax charges apply. This is partly because of the design of the investment and the complicated tax rules that apply to investment bonds.

The bonds are technically a life insurance policy although this is just there for tax purposes. In fact, it allows offshore bonds pay little to no tax on gains while they grow. Onshore bonds pay the basic rate of tax in theory although in practice this is less than 20%.

It is possible to withdraw 5% of your original investment tax-free and this is accumulative so if you don’t take it one year you can take it the next.

However, once the last assured person dies and the bond is surrendered, the tax payable is due not only on the bond value but on the withdrawals as well. The bond will be classed as income for the tax year that it is surrendered. This makes investment bonds a tax issue and a nasty tax surprise. Depending on the value you could incur a tax rate of up to 45%.

To avoid a massive tax liability careful planning is needed and you will need the help of a financial planner.


Ideas to Avoid Investment Bond Tax Liabilities

  • Encash in a Low Income Year – As the tax applies in a specific tax year liabilities can be significantly reduced by encashing in a low income year. If you are a business owner or are drawing a pension, it could be possible to lower your income to reduce the liability significantly.

  • Change Ownership prior to Encashing – It is possible to change ownership of the bond without a tax charge. The original owner must not receive anything for transferring the bond and it must be given as a gift. The receiver will then be free to do as they please with the bond.

    This can be a good option to transfer wealth to a family member especially if their income is low where encashing the bond will not incur a high level of tax liability.

    It is important that the original owner of the investment bond receives no benefits from the bond to avoid issues with HMRC.

  • Encashing the Bond over a Series of Years – Another way to bring down tax liabilities is to cash your investment bond over a series of years. This is because investment bonds benefit from top-slicing. This is where personal allowance is multiplied by the bond duration. If your bond withdraw figure falls within the top-slicing figure tax liabilities are significantly reduced.

    For onshore bonds that fall within the basic tax rate, there would be no further tax to pay. Offshore bonds would see tax paid at 20%.

    Here is an example.

    John’s investment bond has been up and running for six years making a £120,000 gain. His income this year is £34,500.

    If John encashed the whole amount he would incur a severe tax liability. His bond and his income exceed £100,000 in the tax year. His personal allowance would vanish, and the gain would be liable to a higher-rate tax at 20%. Note that 20% has already been deemed payable. This incurs a tax bill of £24,000.

    Additionally, because his personal allowance is lost, he incurs an additional £2,370 tax. Making his total liability £26,370.

    However, if John is clever he could encash half the bond this tax year and half the next. Now he retains his personal allowance and the whole gain on the bond falls into basic rate band.

    Thanks to top-slicing his headroom is £71,100, (personal allowance x bond duration). This covers the £60,000 released in each of the two years. As the basic rate has already been paid, there is no tax to pay saving John £26,370.

  • Investment Bonds Held in Trusts – Often, investment bonds are held in trusts. This is a great administrative cost saving as only withdrawals greater than the 5% allowance have to be reported to HMRC.

As well as the settlor (the trust creator) additional people (trustees) are assured as well. They tend to be younger than the settlor so the trust can be passed on after the settlor dies.

Once this happens the trust is liable to a 45% tax rate and so steps are needed to reduce this tax liability. One way is to appoint a beneficiary and so tax is applied to their tax rates and allowances, or encash the bond on the year of the settlor’s death or before it happens.


Get in Touch to Avoid Hefty Tax Liabilities

Investment bonds are very complex unwieldy but with the right financial planning tax liabilities can be reduced. I’m an award winning financial planner and can help you make the right choices. Click here and complete the Call Back Service form so you do not overpay on tax.

Source: Financial Planning Matters

For more information, please contact Michele Carby at Holborn Asset Management on +971 50 618 6463 and on e-mail at [email protected]


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