Since the early 90s, UK insurance company bonds have been sold extensively by banks and financial advisers.
These investments can be useful tax planning tools, if used correctly, but care needs to be taken when cashing them in.
Insurance bonds pay the equivalent of basic rate tax at source and this can’t be reclaimed by non-taxpayers. Higher rate tax-payers can withdraw up to five per cent of the original investment and defer paying any higher rate tax until the bond is cashed in.
Where things can get a bit complicated is when a basic rate taxpayer cashes in a bond and the profit takes them into higher rate tax. Top-slicing relief is available to reduce or eliminate the tax in many cases. This works by dividing the profit by the number of complete years that the bond has been held and if, when this divided profit is added to other income, the holder is still in the basic rate tax band, then there is no further tax to
If by adding the profit to other income, the bond owner moves into the higher rate tax band by say £2,500, then by making a net pension contribution of £2,000, the tax can be avoided. If a pension contribution is not possible, due to age or funding restrictions, then another option is to assign the bond to a non-taxpayer before cashing it in. This is a simple process, but one that is often overlooked, yet I have heard of cases where thousands of pounds of income tax has been paid when a simple assignment would have avoided the tax altogether.
It is therefore very important to seek professional advice before cashing in or taking withdrawals in excess of five per cent from an insurance company bond.
David Hill is a Chartered Financial Planner and Trust & Estate practitioner at Hills Financial Planning, 15 Agnew Street, Larne. He can be contacted on 028 28276814 or by email: firstname.lastname@example.org