Case study - Hamish 

Hamish purchased an onshore bond 20 years ago for £200,000. He is the bond-owner, with both himself and his wife, Bonnie as the lives insured. He has never made any withdrawals and the bond is now worth £500,000.  

Their son, Angus, has recently married Elspeth, and they are expecting their first child. Hamish and Bonnie wish to help the couple to purchase their first home. To do this, they want to encash the bond and gift the proceeds to their son and daughter-in-law. They consider 2 options. 

Option 1 – Hamish encashes the bond

Hamish has not previously made any withdrawals from the bond. When he encashes it, Hamish’s chargeable event amounts to £300,000 - The current bond value (£500,000) less the initial purchase price (£200,000).  

Hamish is a Scottish taxpayer, currently earning £150,000 per year. He therefore pays the top rate of Scottish Income tax (48%). 

Although Hamish is a Scottish taxpayer, Scottish income tax does not apply to savings income. This means that the tax rates and bands for the rest of the UK will apply when calculating the chargeable event gain on the bond. 

As Hamish’s earnings exceed £125,140, he gets no benefit from top-slicing relief. His tax charge is therefore: 

• Chargeable event of £300,000 @ 45% additional rate tax = £135,000 
• Less basic rate tax credit of £300,000 @ 20% = £60,000
• Tax due (£135,000 - £60,000) = £75,000 

Option 2 – The bond is assigned before encashment

Hamish has not used any of his annual 5% tax deferred allowance. As this is cumulative, and he has held the bond for 20 years, he can therefore withdraw 5% x 20 = 100% of his initial investment without incurring a chargeable event.

Hamish therefore withdraws the maximum £200,000 tax deferred allowance. As his bond is segmented into 30 individual policies, he is then able to assign the remaining £300,000 as follows: 

• 8 policies worth £80,000 to his wife, Bonnie (who earns £20,000pa)
• 6 policies worth £60,000 to his son, Angus (earning £40,000pa)
• 16 policies worth £160,000 to his daughter in law, Elspeth (earning £10,000pa)

When the bond is encashed, the new owners will be treated as if they have held the bond since inception for chargeable event purposes.

Each individual segmented policy is worth £10,000, so the top slice on each is £500 (£10,000 / 20 years held). Adding the top sliced gain to their earnings will produce the following results:

• Bonnie: £20,000 + (£500 x 8 policies) = £24,000
• Angus: £40,000 + (£500 x 6 policies) = £43,000
• Elspeth: £10,000 + (£500 x 16 policies) = £18,000

As the top sliced gain will not place Bonnie, Angus or Elspeth’s total earnings into higher rate tax (above £50,270), they will have no further tax to pay on the bond when encashed. 

For Bonnie and Angus, when they encash the policies assigned to them, the chargeable gain added to their earnings will equal £100,000. This means they have no further tax to pay on their earnings either. 

However, for Elspeth, the chargeable gain (£160,000) will take her income to £170,000. As the personal allowance is eroded by £1 for every £2 of earnings above £100,000, she will find that her £10,000 of earnings are now subject to the Scottish starter rate (19%) and Scottish basic rate (20%) of tax. This results in an additional tax liability on her earnings of £1,976.94. 

To avoid this additional £1,976.94 income tax liability, Elspeth could decide to only encash 9 policies (worth £90,000) in the current tax year and encash the remaining 7 policies (worth £70,000) in the next tax year. This will ensure her total income (earnings + total bond gain) does not exceed £100,000.   

Option 2 can therefore greatly reduce or fully eliminate the tax liability of £75,000 that Hamish would otherwise have incurred. 

Comment

As we can see, use of the 5% tax deferred allowance, top-slicing and the ability to assign cluster policies to new owners can provide a lot of flexibility when realising a bond investment. This can enable the owner to significantly reduce or eliminate a tax liability, even when they are a higher or additional rate taxpayer.   

Important information

Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.

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