tax on assignment of investment bonds

Guide to Investment Bonds and Taxes

Written by a TurboTax Expert • Reviewed by a TurboTax CPA

For new investors, it can be hard to determine your tax liabilities from your investments. Reading up on the available types of bonds and their tax consequences can help you make informed decisions on your investments and how they are taxed.

• Stocks & bonds

What are investment bonds?

Why invest in bonds, types of investment bonds, how are bonds taxed, tax on interest, tax on capital gains, turbotax has you covered.

Stocks & bonds

When people talk about investing, the phrase "stocks and bonds" tends to come up a lot. But why exactly should you invest in either of these options? Understanding the basics of investing in bonds is an important part of getting started as an investor and choosing the best investments for yourself.

Here's a guide to help you determine why you might invest in bonds, the types of bonds available, and what else you need to know about this crucial piece of an investment portfolio.

When you purchase a bond, you're essentially lending money to a company or government. Companies and governments issue bonds to raise money for business operations, expansions or large infrastructure projects.

Over the bond's term, you earn interest on the amount of the bond at an agreed-upon rate. This rate is typically fixed for the life of the bond it can change for some bonds. That fixed, agreed-upon interest rate is why bonds are also typically known as "fixed income" investments — because you get back a fixed amount. On most bonds’ maturity date, you receive back the bond's par or face value.

When a bond is first issued, the price you pay for the bond is usually its par value. For example, you might purchase a bond with a par value of $1,000 at a 4% interest rate (also known as its coupon rate).

After a bond is issued, investors can also sell it before its maturity date. At this point, the bond may sell at a "premium" or "discount." When an existing bond offers a higher coupon rate than the rate currently offered on new bonds, it typically trades above (premium) its par value on the secondary market and becomes a premium bond.

When a bond offers a lower coupon rate than the rate currently offered on new bonds, it typically trades below (discount) its par value and becomes a discount bond.

Investing in bonds offers several advantages over other investments. First, they're a relatively safe investment compared to stocks because their value doesn't usually fluctuate as much as stock prices do. This is why they're a popular option for diversifying your investment portfolio. While bonds typically don't generate the big returns that investing in stocks may deliver, they can provide stability for your investment portfolio. Having a mix of both stocks and bonds can reduce your financial risk when the stock market fluctuates.

Another advantage of investing in bonds is their predictable income stream. Because bonds pay a fixed amount of interest (typically paid twice per year), you can typically count on that income. Depending on the type of bond you invest in, that income may even be tax-free.

Of course, like other types of investments, there is some element of risk when investing in bonds. While it's uncommon, the bond issuer can default on its bond obligations. When that happens, you can lose out on interest payments, not get your initial investment back, or both.

Bonds come in a variety of forms. Here are some of the most common categories.

• Corporate bonds . Companies, including well-known names like Apple, Walmart, ExxonMobil, and Pfizer, issue corporate bonds. Corporate bonds tend to offer higher interest rates than other types of bonds, but the risk of default is higher. To reduce the risk of losing money due to default, check out the credit ratings on corporate bonds issued by agencies like Standard & Poor's and Moody's. Corporate bonds that have a lower credit rating are known as high-yield or junk bonds. Because the risk of issuer default is higher, the interest rate (or yield) is usually higher.
• Municipal bonds . Municipal bonds, also known as "muni bonds," are bonds issued by states, counties, cities, and other state and local government agencies. Municipal bonds are usually issued to pay for large, expensive capital projects, such as building hospitals, schools, airports, bridges, highways, water treatment facilities, or power plants.
• U.S .  Treasury bonds . The U.S. government issues these bonds, which are generally considered to be the safest investments. Because the default risk is lower than that of corporate bonds, they usually pay a lower interest rate. U.S. Treasury bonds are divided into three categories, depending on their maturity. T-Bills come in four-week, eight-week, 13-week, 26-week, and 52-week maturities. T-Notes have maturities of two, three, five, seven, or 10 years. T-Bonds mature in 30 years.

To invest in corporate and municipal bonds, you typically must use a broker. You can buy treasury bonds directly from the U.S. government through TreasuryDirect without going through a broker.

For some investors, selecting individual investment bonds can be intimidating. That's why many people choose to invest in bond mutual funds rather than individual bonds. Bond mutual funds hold a large number of bonds with a variety of maturity dates, interest rates, and credit ratings. This can make it much easier to diversify your bond portfolio because the fund invests in the bonds and you have an interest in a small amount of each bond within the fund rather than investing a large sum into a single bond.

Bonds are typically taxed in two ways: when you earn interest on the bond and any capital gain on the sale.

When you earn interest, the IRS expects you to report that income on your tax return. Whether or not that income is taxable depends on the type of bond you invest in.

• The interest you earn on corporate bonds is generally always taxable.
• Most all interest income earned on municipal bonds is exempt from federal income taxes. When you buy muni bonds issued by the state where you file state taxes, the interest you earn is usually also exempt from state income taxes. If you buy muni bonds issued by another state, you'll still typically avoid federal taxes, but you'll likely be subject to state (and possibly local) income taxes.
• U.S. Treasuries are exempt from state and local income taxes but are taxable at the federal level.

After the end of the tax year, your financial institution or the bond issuer should send you a Form 1099-INT reporting all the taxable and tax-exempt interest you received during the year. Typically, interest from corporate bonds will be in Box 1, interest from U.S. Treasuries will be in Box 3, and tax-exempt interest from muni bonds will be in Box 8.

Even if you don't have to pay income tax on the interest, you still need to include it on your tax return. That's because, while some bond interest is tax-exempt, the IRS still includes it in some calculations. Perhaps most notably, if you receive Social Security income, tax-exempt municipal bond interest can impact how your Social Security benefits are taxed.

The IRS includes muni bond interest in your modified adjusted gross income. If half of your Social Security benefit plus other income, including tax-exempt muni bond interest, is between $32,000 and $44,000 for a joint tax return ($25,000 to $34,000 for single filers), up to 50% of your Social Security benefits may be taxable. Above those thresholds, up to 85% of your benefits could be taxed.

If you buy a bond when it is issued and hold it until maturity, you generally won't have a capital gain or loss. However, if you sell the bond before its maturity date for more than you paid for it, you'll typically have a capital gain. If you sell it for less than you paid for it, you'll usually have a capital loss.

After the end of the tax year, your financial institution will send you a Form 1099-B reporting any bond sales that took place during the year.

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The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.

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• Assigning Bonds

Investment Bond Assignment

Published / last updated on 23/09/2021.

Assignment of an Investment Bond.

What is an Assignment?

It is a change of ownership of a life insurance investment bond, or capital redemption bond, or segments of either type of investment bond.  The change of ownership should be supported by a proper legal document – a deed of assignment.

When you assign an investment bond the person you have assigned it to becomes the beneficial owner, as if they had owned the bond from day one i.e.  the start date of the investment.

What are the Benefits of Assigning?

No Capital Gains Tax: It is possible to gift an investment bond to an adult child without causing a capital gains tax charge.  Gifting other types of investment would be a disposal for capital gains tax purposes.

No Initial Income Tax Charge: An assignment does not trigger a chargeable event and does not give rise to an income tax charge, provided the assignment is not for money or money’s worth.  If you are making a gift then that is not for money or money’s worth.

Transfer to a Trust: It is possible to transfer an investment bond to an individual or to a trust for inheritance tax planning without causing an income tax or capital gains tax charge.

Minimise Income Tax: Providing an outright gift is made it’s possible to minimise income tax on encashment by putting the investment bond or segments of the investment bond into the hands of a taxpayer who will pay a lower rate of tax on encashment (or indeed no further tax the enchasment keeps the person still in the Basic Rate Tax Bracket used Top Slicing Rules )

Inheritance Tax Planning: The assignment is technically a gift for Inheritance Tax purposes.  Any gift you make is taken into account for Inheritance Tax purposes.  If you survive for 7 years after making the gift then the full value of the bonds should fall outside your estate for Inheritance Tax calculation purposes.

Other Tax Planning Opportunities when Assigning a Bond

University Funding - A policyholder can assign an investment bond to an adult child to cover university costs at a time when the child’s personal allowance is unused and/or there would be no further tax to pay on an onshore investment bond because any gain, or top-sliced gain, would be within the basic rate tax bracket (assuming the student is a non, lower or basic rate taxpayer).  By assigning your bonds they can use them for themselves if needed and when needed to provide financial assistance through university.  It may even be that you gradually assign bonds over to fund education.

Efficient Income Planning - Assigning the policy to a lower rate tax payer within your family when/if income or capital needs as again, similar to the above, you can control tax liabilities.

Disadvantages of Assignment

The bond is now owned by another person.  You lose control, it is not your money anymore.

If this new person/owner dies then the full value of the bond could be taken into account for inheritance tax if you have not used a trust.

If this new owner divorces then the full value of the bonds could be taken into account in any divorce settlement.

Insurance investment bonds represent one of the most flexible investment products available in the market and have been so since 1968 (when the relvant tax law came into force).

They are tax efficient in terms of real investment fund gains being offset against expenses and losses by the insurer within the fund meaning that lower taxes may be paid by the fund itself and then you owners can benefit from zero or lower taxation depending upon their own tax status.

In your hand they are free of capital gains tax.

In your hand, you can withdraw up to 5% per year of the original investment without an immediate liability to income tax.  There may be a liability if you withdraw more and you are a higher rate tax payer ( top sliciing relief ).  If you are a basic rate tax payer and any full encashment does not take you over the high rate tax threshold, then there is no further tax liability.  In addition, the 5% per year withdrawal does not affect age allowance (the additional personal income tax allowance currently available (but stopping in 2015 for the over 65’s).

Currently, insurance bonds may not be included in any care fees funding means test.

Finally, as mentioned above, bonds can easily have ownership changes by deed of assigment or be placed in trust (as they are life insurance fund investments) – this can be excellent for tax and estate planning.

Getting Advice on Assignment

Insurance Investment Bonds may be advantageous for people in retirement when income planning, inheritance tax planning and care fees planning.  They can be excellent tools for school fees and university fees planning as well as a way for higher rate tax payers to invest today and receive income or growth without incurring an immediate higher rate tax liability with options to keep for when you are a lower rate tax payer in retirement or assign ownership to others who may be nil, lower and basic rate tax payers.  Contact the team for insurance bond assignment help .

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Assignment of an Investment Bond

Table of Contents

What is an Assignment? It is a change of ownership of a life insurance investment bond or capital redemption bond or assignment of policy ‘segments’ of either type of investment bond. The change of ownership is supported by a proper legal document – a deed of assignment.

When you assign an investment bond or policy segment the person you have assigned it to becomes the beneficial owner, as if they had owned the bond from day one i.e. the start date of the investment.

What are the Benefits of Assigning?

No Capital Gains Tax : It is possible to gift an investment bond to an adult child without causing a capital gains tax charge. Gifting other types of investment would be a disposal for capital gains tax purposes.

No Initial Income Tax Charge: An assignment does not trigger a chargeable event and does not give rise to an income tax charge, provided the assignment is not for money or money’s worth. If you are making a gift then that is not for money or money’s worth.

Transfer to a Trust: It is possible to transfer an investment bond to an individual or to a trust for inheritance tax planning without causing an income tax or capital gains tax charge.

Minimise Income Tax: Providing an outright gift is made it’s possible to minimise income tax on encashment by putting the investment bond or segments of the investment bond into the hands of a taxpayer who will pay a lower rate of tax on encashment.

Inheritance Tax Planning: The assignment is technically a gift for Inheritance Tax purposes. Any gift you make is taken into account for Inheritance Tax purposes. If you survive for 7 years after making the gift then the full value of the bonds should fall outside your estate for Inheritance Tax calculation purposes.

Other Tax Planning Opportunities when Assigning a Bond

University Funding – A policyholder can assign an investment bond to an adult child to cover university costs at a time when the child’s personal allowance is unused and/or there would be no further tax to pay on an onshore investment bond because any gain, or top-sliced gain, would be within the basic rate tax bracket (assuming the student is a non, lower or basic rate taxpayer). By assigning your bonds they can use them for themselves if needed and when needed to provide financial assistance through university. It may even be that you gradually assign bonds over to fund education.

Efficient Income Planning – Assigning the policy to a lower rate tax payer within your family when/if income or capital needs as again, similar to the above, you can control tax liabilities.

Disadvantages of Assignment

The bond is now owned by another person. You lose control, it is not your money anymore.

If this new person/owner dies then the full value of the bond could be taken into account for inheritance tax if you have not used a trust.

If this new owner divorces then the full value of the bonds could be taken into account in any divorce settlement.

Insurance investment bonds represent one of the most flexible investment products available in the market and have been so since 1968 (when the relvant tax law came into force).

They are tax efficient in terms of the underlying assets growing free of any deduction of capital gains tax or income tax, they also attract both time apportionment relief and top slicing relief.

Currently, insurance bonds may not be included in any means tests (for example, for care home fee’s).

Finally, as mentioned above, bonds can easily have ownership changes by deed of assigment or be placed in trust (as they are life insurance fund investments) – this can offer excellent opportunities for tax and estate planning.

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• Personal Finance News

Do Bond Losses Open Tax-Loss Harvesting Options For You? It Depends.

Advisors say a wide array of factors are at play that could make it a good decision or a terrible one

Alistair Berg / Getty Images

KEY TAKEAWAYS

• For the second straight year, market losses have opened up tax-loss harvesting strategies for bond investors.
• Harvesting losses on the sale of investments for tax purposes can constitute a great strategy—or a "terrible one."
• Determining whether to do so should take into account an investor's income, tax bracket, investment strategies and overall financial situation.

After a long-term bull market in bonds that lasted for more than three decades, fixed-income investment losses have put tax-loss harvesting strategies back into play for the second straight year. But whether investors should apply them depends on a lot more than their annual performance statement.

Instead, financial advisors said investors considering using losses to shield them from tax liability should take into account a variety of factors—their annual income and tax bracket, their broader investment strategies and their overall financial situation—before making a decision.

"Depending on the answers, tax-loss harvesting can be a great strategy. Or a terrible one," said Michael Powers, a financial advisor with Manuka Financial in Richmond, Va.

What's Tax Loss Harvesting?

Taxpayers can use losses incurred on certain investments to reduce their exposure to taxes from gains elsewhere or to reduce their overall tax liability.

For instance, an investor realizing a $20,000 gain on the sale of an investment must pay a capital gains tax. However, if the investor has a $10,000 loss on other investments, they can "harvest" those losses to reduce tax liability on the $20,000 investment gain.

If your losses exceed your gains, you can claim up to $3,000 of tax loss deduction per year and can carry over the loss to future tax years.

Factors Affecting Tax Loss Harvesting Decision

The amount of capital gains tax you owe will depend, though, on whether you bought the investment less than a year before selling it (a short-term gain taxed at your ordinary income tax rate) or more than a year before selling it (a long-term gain).

For long-term gains, individuals making less than $44,625 (or $89,250 for married filers) have no long-term capital gains tax exposure; tax liability increases at graduated levels for incomes higher than that .

However, you should remember that losses in non-taxable accounts—such as individual retirement accounts (IRAs) and 401(ks)—comprising 56% of all U.S. mutual fund assets don't qualify for tax-loss harvesting.

Why Now? Easy, Bond Market Distress

For years, investors primarily used losses from stock investments for tax-loss harvesting. That's mostly because, aside from a few years of relatively modest losses, bond returns generally moved higher.

That changed last year when U.S. bonds posted their worst returns since before the Revolutionary War. This year, bond yields have continued rising, with the benchmark 10-year U.S. Treasury recently topping 5% for the first time in 16 years . The iShares Core U.S. Aggregate Bond ETF, reflecting a broad swath of the U.S. bond market, has fallen 5.7% year-to-date.

With yields higher than they've been in years, investors actually could sell underperforming bonds, use the proceeds to reinvest in higher-yielding bonds and then harvest the tax losses from the initial sale.

However, Powers said such short-term opportunities shouldn't override a more holistic approach.

"If your income is low due to a job loss and you can take long-term capital gains at 0%, it would not make any sense to harvest losses when they could be used to offset gains and/or ordinary income in future years when your income is higher," he said.

Indeed, investors don't have to harvest tax losses in the year they occur. They can carry up to $3,000 in losses forward each year to future years.

Other Considerations

Investors also must make sure that they avoid rules on so-called " wash sales ." In addition, if they repurchase an investment similar to one sold at a substantial loss, they simply may incur a large capital gain later when the value of the investment recovers, negating tax-loss harvesting advantages in the long term.

Steve Oniya, an advisor with OM Investments in Houston, said investors should consider the investment's potential and its fit for their portfolio prior to selling for tax-loss purposes, particularly with fixed-income investments.

"It's frequently wise to ignore short-term losses due to volatility and hold fixed income until maturity to gain your reward," Oniya said.

Justin Ricci, an advisor with Warren Street Wealth in Newport Beach, Calif., said harvesting tax losses also can help investors ease the capital gains hit of selling legacy assets, such as a house whose value has appreciated considerably over time.

Ricci also said investors seeking to diversify away from risk in a single investment, such as a stock whose value has appreciated considerably, can use tax-loss harvesting to their advantage: selling the stock for a gain, reinvesting in more diverse assets and harvesting losses to reduce the tax impact of selling the stock.

He added that volatile years make tax-loss harvesting even more attractive, noting that investors can harvest tax losses frequently and at any time—not just at the end of the year.

"In years of extreme volatility, you may be able to accumulate a large amount of tax losses in a short period of time," Ricci said, adding that frequently doing so "can have a big impact on your tax bill."

Internal Revenue Service. " Topic No. 409 Capital Gains and Losses ."

Investment Company Institute. " Investment Company Fact Book. "

CNBC. " 2022 was the worst-ever year for U.S. bonds. How to position your portfolio for 2023. "

Tradingview. " iShares Core U.S. Aggregate Bond ETF ."

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Arnold Aaron provides an introduction to the taxation of a popular form of investment known as the Investment Bond. 

Chargeable event certificates, partial surrenders, top slicing relief, 5% allowances… the list goes on. The Investment Bond available through Life Companies has existed since the early 1970s if not earlier.  Because they have their own unique tax rules, policyholders and on occasion tax practitioners are sometimes in a muddle over the tax treatment. This article is intended to shed some light on how it all works.

The Investment Bond is basically an investment vehicle offered by life assurance companies, and although an investment, it does not fall under the Capital Gains Tax (CGT) regime because technically it is classed as a life policy. Firstly we’ll look briefly at the conditions which trigger a chargeable event which could result in a gain and therefore a potential tax liability.

A Chargeable Event is triggered on:

• Death of the owner of the investment bond
• Assignment of the bond for money or money's worth
• Maturity or full surrender of the investment bond
• Partial Surrender in excess of the 5% allowances (see below)

5% withdrawals rules

One is permitted to withdraw 5% of what was invested, each year the policy is in force without any immediate liability to tax, or having to declare anything on one's tax return. If withdrawals are not taken each year, the allowance is carried forward. Here’s an example.

An investment of £100,000 is made in Jan 2004. £5,000 can be withdrawn during each policy year with no tax to pay at the time.  If no withdrawals are made, then for example in Feb 2008 which is actually 5 policy years (when lookin to see if there's an excess, part-years count as a whole year), 25% or £25,000 in this case can be withdrawn (5% x 5years), again with no immediate liability to tax.  Let’s call this example 1.

Calculating the gain on an excess over the 5% allowances

At the end of each policy year, a comparison is made over the available 5% allowances against the amount actually withdrawn from the policy. If during the policy year one has withdrawn more than the 5% allowances then a Chargeable Event certificate for the ‘excess' is issued on the policy anniversary with the ‘Gain' being for the excess i.e., the amount withdrawn over the allowance.  Taking the example above, if in Feb 2008 £35,000 was withdrawn, a Chargeable Event Certificate would be issued in Jan 2009 (on the policy anniversary) showing a ‘gain' of £10,000 .  This gain will be classed as having occurred during the tax year 2008/09, and is taxed as described later on.  Let’s call this example 2.

Calculating the Gain on Full surrender

Now we understand what the tax treatment is on a withdrawal from an investment bond let’s have a look at the tax treatment of a full surrender.

Calculating the ‘Gain' on the policy for a full surrender is a simple formula:

GAIN = Current value + previous withdrawals - initial investment - previous excesses

Taking example 2 above, suppose the Investment Bond was worth £150,000 in March 2010 (after having made a withdrawal of £35,000 in Feb 2008 - yes, what spectacular investment growth!) the GAIN on full surrender of the £150,000 would be:

GAIN = £150,000 (current value) +  £35,000 (previous withdrawals) - £100,000k (initial investment) - £10,000 (previous excess) = £75,000.

For a full surrender, the Chargeable Event Certificate is issued as at the date of the full surrender, in this case March 2010 for a Gain of £75,000. This is then taken into account in the tax return for the tax year 2009/2010.

Now that we’ve seen how the Gains are calculated, the good news is that no tax advisor or policyholder should ever need to do these calculations themselves as these figures are given on the Chargeable Event certificate. In addition, before making the surrender, a simple telephone call to the Life Company with which the policy is held is all it takes and they should be able to tell you straight away what the Gain will be on making either a full or partial surrender.  After all, it is they who will be producing the chargeable event certificate.

Let’s now look at how the Gain is treated for tax purposes.

How Gains are taxed

For an onshore UK Investment Bond, if the policyholder is already a higher-rate taxpayer in the tax year the Gain occurs, he simply pays tax of 20% of the ‘Gain' with no further liability, the reason being that an investment bond is deemed to have paid basic rate tax at source.

For basic-rate and non-taxpayers, they can benefit from what is known as ‘ top-slicing relief ', which works as follows.

One simply takes the gain, and divides it by the number of full policy years the investment has been in force to give what’s known as the average gain.

e.g. In our example above where a full surrender of a policy worth £150,000 resulted in a gain of £75,000, we divide £75,000 by 6 complete policy years (2004-2010) to give £12,500.

We then add £12,500 to the policy holder’s other total taxable income for the tax year in question and if the result is less than the higher-rate tax threshold there is no tax to pay. If the result exceeds the higher-rate tax band, then we calculate by how much and multiply it back by 6 policy years.  Take this example;

e.g. Say a policy holder has other taxable income of £30,000 in tax year 2009/10, we add £12,500 which gives a total of £42,500.

For tax year 2009/2010 higher rate income tax applies above £37,400 of taxable income so; 

£42,500 - £37,400 = £5,100. (This is known as the top slice).

We then multiply by the number of whole policy years, thus

£5,100 x 6 = £30,600. This is the taxable Gain and is taxed at 20% with no further liability, hence 20% of £30,600 = £6,120 tax liability.

When one puts this in perspective, in this case the investor made a total profit of £85,000 including the withdrawal of £35,000, over a 6-year period and the investor himself only paid £6,120 in tax on the profit - an effective tax rate of 7.2% - much less than CGT at 18%!

Policyholder and tax advisor beware costly partial surrender?

Consider the following case:

£150,000 was invested in an Investment Bond in July 2007.  Due to the adverse investment conditions, the bond fell in value, and was valued at £135,000 in January 2009. The policyholder wanted to make a partial withdrawal and, thinking the policy was in loss meant there would be no tax to pay, went ahead and withdrew £50,000, after all you don’t pay tax on a loss, do you..?

Following through our calculations for a partial withdrawal using the 5% rule as in examples 1 and 2, the 5% allowance accumulated on this policy is 5% of £150,000 x 2 policy years = $15,000.

In this case withdrawing £50,000 results in an excess and consequently a Gain of £35,000 in July 2009, to go on the 2009/2010 tax return. So we can clearly see here that making a partial surrender can trigger a tax liability even though there is no profit, because excess calculations do not take into account whether there is actual profit or loss on the policy. Only in the tax calculation on final surrender do we take account of the profit or loss where there can only be a gain when there is profit.  However, in our case having to fully surrender a £150,000 policy, when all that is needed is £50,000 is a rather inefficient way of doing things.

To avoid such an undesirable scenario many providers now issue their Investment Bonds as segmented mini-policies, perhaps made up of 1,000 identical mini-policies or more. One therefore makes a full surrender of individual mini-policies to raise the amount needed and avoid a Gain, particularly when there is a loss on the investment. The calculation is just as we saw earlier in calculating the Gain on a full surrender, which in this case is as follows:

GAIN = Current value + previous withdrawals - initial investment - previous excesses GAIN = £135,000 + 0 - £150,000    = MINUS £15,000 or Zero Gain.

We can clearly see then that as there is no profit, there is no gain, and one can confidently fully surrender individual policies and not trigger a tax liability. In this case the policy is made up of 1,000 mini-policies (each now valued at £135), and as we want to withdraw £50,000, we simply fully surrender (£50,000/£135  = 371) 371 mini-policies, or policies 1 through 371 inclusive.

As has been illustrated, policyholder and tax advisor alike must tread carefully when wanting to make a partial surrender.  All too often policyholders simply send in an instruction to the life office requesting a partial withdrawal without consideration of the tax position or seeking advice, resulting in a totally unnecessary tax bill. Again, rather than ploughing through these calculations, all it takes is a telephone call to the Life Office beforehand asking what the gain would be if withdrawing the required amount on doing a partial surrender across all mini-policies (as in examples 1 and 2) and on a full surrender of a number of mini-policies (as in the last example) to raise the required amount. They will even give you the number of years to use for top-slicing relief. The point here is that this should be done before making the withdrawal.

The only time Accountants need get involved in calculations is for top slicing relief, and Solicitors are only ever likely to meet these rules when doing probate work.

Additional points:

• Additional investments or top-ups to a policy will produce their own 5% allowances.
• 5% allowances build up over a maximum of 20 years and once 100% (5% x 20 yrs) has been withdrawn any further partial withdrawal results in an excess
• For the top-slicing relief calculation, in the case of an excess on a partial surrender, the gain is divided by the number of years since the last excess, not the number of complete policy years as in the case of a full surrender. If there has been no excess previously, then one can use the number of years including part-years since inception.
• For top-slicing relief, remember the average gain is added to taxable income, so although the higher-rate tax threshold is £37,400 (tax year 2009/10), one generally benefits from the personal allowance (£6,475 tax year 2009/10) and so one can earn up to £43,875 (including the average gain added to other income) before a gain becomes taxable. 
• Certain allowances, such as Age Allowance for those over 65 or Children’s Tax Credit depend on overall income. As the total gain (without averaging) is treated as part of your income for that year, these allowances may be reduced or eliminated by the gain.
• If an excess and a full surrender occur in the same tax year, the excess is ignored. The calculation of the gain on cashing-in takes the withdrawals into account.
• When the policyholder dies, it is treated as if they fully surrendered their bond one day before death, and any gains are included in their final income tax calculation in the year of death - this is where probate lawyers are likely to encounter these policies.
• For an Investment Bond in Trust the gain is generally taxed against the settlor if alive and if not alive, then the Trustees, except in the case of a Bare Trust where gains are always assessed against the beneficiaries.
• If the bond is owned jointly, the gain is split according to their respective share.
• Full information can be found in HMRC help sheet HS320: HMRC Help Sheet HS320

Tax planning opportunities

One will notice that, unlike in the case of a Unit Trust investment, switching funds does not result in a Chargeable Event and therefore no tax liability. Nowadays on modern policies, with the a plethora of investment funds to choose from, everything from low risk and cash funds to speculative commodity investments is available and this versatility allows an investor to time his investment decisions without being bound by tax considerations, which is often the case with other investment structures.

In addition the gains are assessed against the policyholder’s income in the tax year when the gain arises.  With some clever planning, one could be a higher-rate tax payer throughout one's working life, make 5% withdrawals to raise extra income and then on retirement when income drops into the basic rate band, one could benefit from top-slicing relief having had the policy over many years, and withdraw potentially substantial sums without incurring any tax. 

Another valuable opportunity, sadly little advertised, is where the policyholder remains a higher-rate taxpayer, he can exploit his spouse’s basic-rate or non-tax status by transferring ownership of the bond to the spouse at the time they want to make the surrender. They may then immediately go ahead and make the surrender and the gain is assessed on the income of the spouse.  As the transfer of ownership is a deed of assignment by way of gift and not for money or money's worth, it is not a chargeable event.   

Similarly, in the case of surrendering a trustee investment one could avoid trustee tax by assigning the investment bond to the beneficiaries first and then making the surrender.

As investment bonds are classed as non-income-producing (any income derived accumulates as capital growth) they are particularly appropriate for Trustee investments, which also means they are ideal vehicles for Inheritance Tax planning, one example being the Discounted Gift Trust; The Discounted Gift Trust

Investment Bonds enjoy their own tax rules and with the right guidance open up many tax planning and investment opportunities. As has been illustrated, seeking advice is paramount at every step of the process, and it is indeed a shame that lack of understanding of a system which is not particularly complicated has meant these investments often don’t get the publicity that they deserve.

About The Author

Specialist Inheritance Tax Planning & Investments

Arnold Aaron provides investment, estate planning and financial advice to private clients, company directors, pension funds and charities, and offers a consultancy service to accountants, lawyers and their clients.

78, York Street London W1H 1DP

(T): 0207 692 0884

(E):  [email protected]

(W):  arnoldaaron.co.uk

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