Put another way, policyholders have no liability to CGT or basic rate income tax in relation to proceeds in the bond while they are invested.
In addition, it is possible for policyholders to withdraw up to 5 per cent of the amount invested each year without any immediate liability to tax, subject to an overall maximum of 100 per cent.
Any unused element of this allowance can be carried forward to subsequent years. Adviser fees paid from the bond count towards this allowance.
Switches in and out of funds are not subject to a CGT or income tax liability and no reporting is required. This tax treatment applies to trustees as well as individual applicants.
When does tax apply?
Because bonds are subject to the chargeable event regime, this means that a policyholder may incur an income tax liability in relation to gains made and calculated at some specific events:
- In the event of death, although this can be mitigated by having multiple lives assured to avoid an immediate liability on the death of the applicant(s).
- On certain assignments (that is the transfer of legal ownership of part or the entire bond for money or money’s worth).
- On full encashment.
What tax is payable on withdrawals over the 5 per cent allowance?
Well, for a higher- or additional-rate taxpayer, any chargeable event will be subject to tax at the difference between the basic rate and higher- or additional-rate income tax, but a basic or nil-rate taxpayer pays no tax, unless the gain takes them into a higher rate bracket.
In the latter case, this can be mitigated by ‘top slicing’ relief, which works by dividing the gain over the lifetime of the bond by the number of years the bond has been held, and using this figure to calculate if there is a change of tax bracket).
Nil-rate taxpayers cannot reclaim tax paid in the bond, meaning it is not a suitable investment option for these customers.
Bonds are non-income producing assets so there are no annual tax returns for individuals or trustees to complete and therefore no associated accountancy costs.
And because a bond is classed as a 'non-income producing asset', it only needs to be included in the calculation of income on a self-assessment return when a chargeable event has occurred.
When a chargeable event occurs which results in a gain, the insurer is required to produce a chargeable event certificate showing the gain figure, meaning the policyholder does not have to calculate this themselves.
Any gains are subject to income tax and not capital gains tax. The timing of any tax liability can generally be managed as it will only be triggered when there is a chargeable event.
