We use cookies to give you the best possible online experience. By clicking Close you indicate that you are happy for your web browser to receive all cookies from our website including cookies that are linked to your personally identifiable information. See our cookie policy for more information on cookies and how to manage them.

Tech centre - Financial planning bulletin

Onshore Investment Bond Surrenders and Top Slicing

May 4, 2018, 15:32 PM

Summary


Withdrawals from an onshore investment bond fall under the chargeable events income tax regime. Each policy year the investor can withdraw up to 5% per annum (cumulative, to a maximum of 100%) of the initial amount paid by the investor without any immediate liability to income tax. If a withdrawal exceeds the cumulative 5% allowances this is a chargeable event at the end of the policy year and the amount of the excess is a chargeable gain..

In this bulletin we look at the operation of top slicing tax relief on a chargeable gain to potentially avoid or reduce any income tax liability.

Facts and analysis


Top slicing is a tax relief that can reduce or even eliminate a liability to excess rate(s) of income tax. The liability can arise if an individual withdraws money from an investment bond, which causes a chargeable event resulting in a chargeable gain.

Importantly, it is only helpful if the full chargeable gain makes an individual a higher rate (currently 40%) or an additional rate (45%) taxpayer when it’s added to their other income.

An individual can’t use top slicing to reduce any extra tax they have to pay if the chargeable gain has reduced their entitlement to the personal allowance or some means-tested benefits such as Child Benefit.  It can only be used to reduce or eliminate the need to pay excess rate(s) of income tax caused by a chargeable gain.  Only individuals can claim top slicing, which means that it’s not available to trustees or limited companies.

Calculating the tax

The following steps outline the simple way to calculate the top sliced chargeable gain and the resulting income tax liability. In this instance, the gain means the individual becomes a higher rate taxpayer instead of a basic rate taxpayer.

Step 1

Calculate the amount of any chargeable gain that has arisen in the tax year.

Step 2

Calculate the top sliced gain.

If a chargeable event occurs due to the bond coming to an end (for example, on full surrender), the top sliced gain is the total chargeable event gain divided by the number of complete years the policy has been in force.

If a chargeable event occurs on part surrender the top sliced gain is the chargeable event gain divided by the number of complete years since the last chargeable event (or since the start of the policy if none).

Step 3

Add the slice, as calculated in step 2, to the total of all other income for the tax year in question.

Step 4

Work out how much of the total income figure produced in step 3 falls above the higher rate tax threshold i.e. after deducting allowances such as the personal allowance.

Step 5

Multiply the result of step 4 by 20%, which is the excess rate (higher rate tax minus basic rate income tax) for the 2018/19 tax year.

Step 6

Multiply the figure calculated at step 5 by the total number of complete policy years used in step 2.

The answer you get is the income tax liability on the chargeable gain if you claim top slicing relief.

 

Additional rate taxpayers

Additional rate tax is paid at 45% on taxable income over £150,000. Top slicing relief will help if the full chargeable event gain turns a basic rate taxpayer or higher rate taxpayer into an additional rate taxpayer.

For example, during the 2018/19 tax year Fred has a chargeable event gain of £15,000 on his UK investment bond.  His bond has five complete years for top slicing purposes, so the slice is £3,000. His other income is £148,000 i.e. taxable income after deducting allowances.

Without top slicing relief, Fred would pay income tax of £3,650 on the gain.

(£2,000 x 20%) + (£13,000 x 25%) = £400 + £3,250 = £3,650

With top slicing relief, £2,000 is in the 40% band and £1,000 is in the 45% band. This is how the tax is worked out:

(£2,000 x 20% x 5) + (£1,000 x 25% x 5) = £2,000 + £1,250 = £3,250

Using top slicing relief, Fred saves £400 income tax.

 

Top slicing in practice

Let’s assume a policy has been in force for 10 years and six months. It is cashed in, incurring a chargeable event gain of £50,000.

Top sliced gain = total chargeable gain divided by the number of complete years the policy has been in force

= £50,000/10

= £5,000

Let’s look at three different example policyholders in this situation:

Alice, Brian and Charles each have differing incomes.

 

Alice

Brian

Charles

Income in relevant tax year (after deducting allowances)

£10,000

£30,000

£50,000

Total gain under bond

£50,000

£50,000

£50,000

Top slice (policy held for 10 complete years)

£5,000

£5,000

£5,000

Income plus top slice

£15,000

£35,000

£55,000

Alice won’t have to pay any further income tax. That’s because she is considered to have paid 20% income tax (which covers the basic rate liability) and her income is still below the higher rate income tax band, even after the top slice is added.

Charles who is already a higher rate taxpayer, will have to pay 20% (2018/19 tax year) income tax on the whole gain, which equals £10,000.

The top slice of the gain has taken Brian’s income over the £34,500 higher rate threshold. So, using the step-by-step approach outlined above, you can calculate his income tax liability like this:

Having worked through first two steps:

His top slice gain is £5,000

His taxable income plus top sliced gain is £30,000 + £5,000 = £35,000

(refer to step 3)

Minus the higher rate tax threshold (tax year 2018/19 this is £34,500) = £500

(refer to step 4)

£500 x 20% = £100

(refer to step 5)

£100 x 10 = £1,000

(refer to step 6)

Next steps


Top slicing relief can be used to reduce or even eliminate a liability to excess rate(s) of income tax on a chargeable gain.  When considering any withdrawal from a bond it is important to firstly calculate whether any excess rate income tax will be due, and to consider alternatives including –

  • Spreading the withdrawal over two or more tax years
  • Using partial surrenders and full surrenders of segments for the most tax efficient option
  • Making a pension contribution in the same tax year as the chargeable gain to extend the basic rate tax band
  • Assigning the bond (by way of unconditional gift) to a lower tax paying spouse prior to taking the withdrawal.  There must be no agreement that the proceeds will be returned to the spouse who originally owned the policy.

Learning outcomes and reflective questions for CII accredited CPD


Reading this article can count towards structured CPD under the CII CPD Scheme if you consider the Learning Objectives below to be directly relevant to your own personal professional development plan. The Reflective Questions don’t require answering, they are aimed to help you reflect on the issues raised in the article for your reflective statement on your CPD Certificate.

Learning objectives:

  • To understand how to use top slicing to reduce or eliminate a liability to higher and additional rates of income tax
  • To calculate the tax due on a chargeable gain on an onshore bond
  • To consider the options to avoid a tax liability on a chargeable gain

Reflective questions:

  • If my client takes a lump sum from an onshore bond what are the tax implications?
  • What tax planning strategies could I use to reduce or eliminate a tax liability on the surrender/part surrender of an offshore bond?

Important information


This information has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2018.  It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice.  Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients.  You should always seek appropriate legal or other professional advice.

Aviva Tech Centre

Protection planning

Umbrellas
Our protection articles can help support your financial planning process and offer the opportunity to earn CPD hours. Find out more

Aviva Tech Centre

Pension planning

Family and dog
Pension planning articles looking at pre-retirement, benefits in retirement and death benefits. Find out more

Aviva Tech Centre

Investments and tax planning

Dolls house
A range of investment planning solutions covering personal and business investments. Find out more

Aviva Tech Centre

Trust and inheritance tax planning

Family on beach
Financial planning opportunities giving you information about inheritance tax and trust planning. Find out more

Back to top