Cashing in an investment the right way to save tax
Cashing in an investment can result in a big tax hit, as one of our subscribers discovered. Would the well established ploy of using so-called top slicing relief save tax, or could they do better?
Can’t defer surrender
One of our subscribers contacted us after she had read our previous advice on how to use investment bonds to leapfrog the new 50% and 60% tax rates (yr.10, iss.13, pg.3, see The next step). She had invested money in a life assurance bond about ten years ago but now needed to cash it in (surrender the policy) within the next few months. But as her income was around the £100,000 mark, she would be clobbered by the new higher income tax rates on the profit the bond made. She wanted to know if there was any way to avoid these.
All or nothing
To keep her tax bill down, our subscriber was considering taking just part of the investment. Fortunately we stopped her in time, as this could have led her into an even worse tax trap (yr. 9, iss. 4, pg. 5, see The next step). So it was a case of all or nothing, but that still left the thorny question of how to tackle the tax bill.
The Taxman’s official option
One option to reduce the tax bill is to use something called top slicing relief (TSR). With the new 50% and 60% tax rates hitting from April 6, TSR is suddenly making the headlines again. The idea behind it is that because the profit on a bond builds up over a number of years, the tax should be calculated in a way to take this into account.
Example. Just over ten years ago Jane invested £30,000 into an investment bond. It’s now worth £55,000. She needs the money and so surrenders the bond in July 2010. Her other income is £95,000. Without TSR Jane would have to pay extra tax on the bond of £7,590, but with it the bill is cut to £5,000 (see The next step). TSR works by slicing (hence the name) the profit up by the number of full years since the bond started. So in Jane’s case the £25,000 profit is divided into ten £2,500 slices. Her tax bill for 2010/11 is then worked out on just one slice and then multiplied by the number of slices, i.e. ten. If the resulting figure is less than the tax that would have been payable by taxing the whole £25,000, then Jane is taxed on the lower amount.
A greater tax saving
Our subscriber’s husband saved the day! As his income is around £40,000 per year it means that he doesn’t pay any higher rate tax. That opened the door for a simple piece of tax planning which means that she won’t have to pay a penny more to the Taxman from the profit on the bond.
Tip 1. Give the bond away. If your spouse pays tax at a lower rate than you, by giving the bond to them before it’s cashed in the tax bill will be worked out at the rates applying to them, not you.
Tip 2. Speak to the insurance company. Many of the companies who sell bonds have standard forms that will make the assignment easy to do. So give them a call.
Trap. This tax-saving plan won’t work if you assign the bond to someone other than your spouse. In that situation the assignment is treated as if you had cashed in the bond at its full market value.
For previous articles on investment bonds (TX 10.14.05A) and (TX 10.14.05B) and how to calculate TSR (TX 10.14.05C), visit http://tax.indicator.co.uk.
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