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Multiple Gains – the simple calculations advisers need to know

It’s widely known that chargeable event gains arising on life assurance policies, capital redemption policies and purchased life annuities are subject to income tax. Most advisers will also understand the chargeable gain calculation where a client only surrenders one investment bond in a tax year. However, what if clients need to surrender more than one investment bond within the same tax year, creating a series of gains?

Where a client surrenders more than one investment bond in a tax year the chargeable gains are not added to that client’s income in order of surrender, but are aggregated and treated as the top slice of their total income.

In this article we consider the impact of chargeable event gains arising on more than one investment bond in the same tax year.

Example

Alexander has surrendered two UK bonds: Bond A in August 17 and Bond B in January 2018. As he surrendered both within the same tax year (2017/18) we must consider the multiple gain rules.  Bond A produced a chargeable gain of £5,000 and Bond B produced a chargeable gain of £4,000, giving total gains of £9,000. Alexander’s income for 2017/18 is £30,000 and when the total gains are added to his income he remains a basic rate taxpayer. As UK bonds, they are deemed to have paid basic rate income tax and therefore Alexander has no further tax liability.

If the bonds had been international then Alexander would have an additional tax liability of 20% x £9,000 = £1,800 on the chargeable gains. This is because potentially there is no tax imposed on the income and gains of the underlying funds of an international bond.

That’s straightforward, but what if the total gains take Alexander into a higher rate tax bracket?  Then top-slicing relief must be considered.

Example

Alexander has surrendered two UK bonds: Bond A in August 17 and Bond B in January 2018. Bond A had been in force for 10 complete years and produced a chargeable gain of £24,000.  Bond B, which had been in force for 4 complete years, gave rise to a gain of £3,600. This gives total gains of £27,600.

Alexander’s income for 2017/18 is £43,000. Adding the total gains to Alexander’s income puts him into the higher rate tax band, so top-slicing relief is available.

The top-sliced gain for each investment bond needs to be calculated and then added together:

Bond A = £24,000 / 10 = £2,400

Bond B = £3,600 / 4 =      £   900

                                               £3,300

As UK bonds, they are deemed to have paid basic rate income tax and £2,000 of the gain is covered by the basic rate tax band. Therefore £1,300 of the top-sliced gain is chargeable at the higher rate of 20%. Additional tax payable on the top-slice is therefore £1,300 x 20% = £260.

Once the additional tax has been calculated it needs to be pro-rata’d across the two bonds being surrendered. This will provide the amount of the additional tax attributable to each individual bond.

Bond A = 260 x (2,400 / 3,300) x 10 = £1890.91

Bond B = 260 x (900 / 3,300) x 4 = £283.64

This gives Alexander a tax liability of £2,174.55.

Let’s now consider the situation where Alexander has surrendered not just the two UK bonds, mentioned above, but also an international bond. When surrendering a mixture of UK and international bonds all the chargeable gains are treated as the highest part of income. This means that the chargeable gain for the international bond will not benefit from the 0% starting rate for savings or the personal savings allowance.