So far this year, members of Canada Life’s ican technical team have answered over 3,000 queries from advisers on a wide variety of subjects.
One of the main topics of conversation has been chargeable events, and below are the top 5 most common queries.
No. 1. Entitlement to personal allowances
The growth in the value of an investment bond and the gain realised on full encashment can be considerable if the bond has been running for many years.
There is a common misconception that it is the top-sliced gain which is added to a person’s income to determine their entitlement to personal allowances and any means-tested benefits.
But even though HMRC allow the gain to be spread over the complete number of years the bond has been in force to calculate the tax liability, they will treat the whole gain as income in the tax year in which the event occurred.
This means that if a large gain is realised the person might lose some or all of their personal allowance.
For example, a bond that has been running for 10 complete years realises a gain of £80,000 on full encashment in the 2017/18 tax year, when the client’s earned income is £29,500 plus savings income of £500. When the whole gain is added to their income it takes them over the £100,000 threshold by £10,000. This means that their personal allowance is reduced to £6,500 (£11,500 – £10,000/2).
The gain can then be top-sliced to calculate the tax liability (20% x £80,000 = £16,000) but remember that the client will have an extra 20% tax liability on £5,000 of their earned income. Also, despite the fact that all the gain will be assessed at the basic rate, the client will have their personal savings allowance reduced to £500.
No.2. Five per cent allowance and top-ups
Calculating the tax-deferred allowance can be difficult when there have been top-ups.
Each year, 5 per cent of the premium paid in that year plus 5 per cent of any premium paid in any previous year can be withdrawn without an immediate liability to income tax. This is known as the ‘tax-deferred withdrawal’ facility. Any allowance not used can be carried forward to future years.
As well as the 5 per cent allowance there is an overall maximum limit. Once 100 per cent of the cumulative allowance has been used then any further withdrawals, regardless of the amount, are considered a chargeable event.
For example, consider a bond commenced on 1 January 2010 with a premium of £100,000. Top-ups were applied on 3 March 2015 (£50,000) and 2 February 2016 (£100,000). In September 2017, the client wants to withdraw all the tax-deferred allowance, having previously made no withdrawals.
The client will have a cumulative tax-deferred allowance of £57,500 (£100,000 x 5% x 8 years + £50,000 x 5% x 3 years + £100,000 x 5% x 2 years).
Remember that, going forward, the client will only have 12 years’ tax-deferred allowance left on the original amount and so on for the top-ups.
No. 3. Multiple gains
It is not uncommon for a client to generate more than one chargeable gain in a tax year, for example if they surrender all of their investments across all companies.