Let us look at how much a client needs to realise to fully use their annual CGT exemption.
- Joan invests £100,000 and this increases in the first year to £120,000.
- When she takes a lump sum from a collective fund then part of this is a return of capital and part is growth.
- When calculating a part disposal, to value the amount of capital being returned HMRC use the following formula:
Capital in the investment
(Original capital less any previous capital withdrawals)
Amount being realised
Amount being realised + remaining value
The balance of any payment is therefore growth and potentially chargeable.
- To realise the full £11,300 exemption, this client would have to sell £67,800 of the investment and reinvest it without breaching the bed and breakfasting rules. This means they would not be able to reinvest in the same fund for at least 30 days, but can choose a similar one, which potentially adds diversification but does mean another CGT calculation the following year.
Over a period of time, more and more of the original capital is returned to the client and then reinvested, leaving the client with numerous funds each with their own CGT calculations, adding complication and additional work to the management of the investment.
Any unused CGT exemption is not carried forward so if insufficient capital gain is realised then some of the exemption will be lost.
Arguably, many will view charges and tax as being the main factors when considering different tax wrappers, but as well as offering simplicity, especially from CGT calculations, a bond can offer other features, including:
- Tax-efficient switching. When the underlying investment is switched, no tax liability arises on the client (unlike a collective investment).This makes managing the investment easier and clients are able to switch to help meet their changing objectives, for example if they approach a time when they are planning to take an income.
- Accessing the investment. A bond allows different ways in which a client can access their money, either by using the 5% tax-deferred annual allowance, by surrendering one or more of the individual policies that make up the bond, or by a combination of both. This allows you and the client to choose the method that is the most tax-efficient.
- The 5% tax-deferred allowance. A client can access regular or periodic lump sums without any immediate tax charge. Each year they can withdraw an amount equal to 5% of the original investment without an immediate tax charge and for tax purposes, these withdrawals are treated as a return of capital. It is a cumulative allowance so any amount unused rolls over to subsequent years. Any amounts taken do come into the tax calculation when the bond is either fully surrendered, assigned for money or money’s worth or when the last surviving life assured dies. This is why it is referred to as tax-deferred.
- Assignability. Whilst assigning a bond in return for money or money’s worth is a chargeable event, assigning it as a gift is not. The ownership of a bond can change and there is no tax liability. The new owner is then treated as owning the bond from outset. This allows them to make use of the available 5% tax-deferred allowance or even surrender the bond using their own tax position. Ideal if the new owner pays a lower rate of tax than the assignor and where an investor may want to pass on wealth to a trust, onto younger generations, or if trustees want to distribute money out of a trust.
The important message here is that onshore investment bonds should not be dismissed simply because there is tax within the fund. Every client will have different objectives. In some instances, a collective investment may be more beneficial than a bond and vice versa. Some clients may be better served by investing in both tax wrappers offering even more flexibility.
Canada Life offers a range of wealth management solutions, including retirement income planning, estate planning and investment solutions from a choice of jurisdictions, including the UK, Isle of Man and Republic of Ireland.
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