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MOST COMMON QUESTIONS ADVISERS ASK – CHARGEABLE EVENTS

Chargeable events

The most common questions advisers currently ask the Trust and Technical Solutions – Life and Investment team is on the topic of chargeable events, for both onshore and offshore bonds. Before making decisions, advisers understandably want to check their understanding of what can be a difficult subject to understand. At a time when some clients are needing access to capital, these types of questions have continued to top the list of questions asked. If your clients are in a similar position, these sample problems and solutions may help.

 

1. Surrender from a discretionary loan trust.

Problem:

My client is the settlor/lender of a discretionary loan trust which holds an offshore bond. In May 2010 a loan of £100,000 was made to the trustees and invested, by the trustees, into an offshore bond. The lender requested 5% of their loan be repaid each year. So far, the trustees have done this via partial surrenders across all policies. A total of £50,000 has been paid to date. This year the lender has requested a repayment of £25,000 from the trustees. The trustees are considering a partial surrender of the policies in order to repay this portion of the loan and would like to understand the implications of this, if any.

Solution:

Partial surrender across all policies.

Partial surrenders utilise the tax deferred allowance. The trustees may withdraw up to 5% of the premiums paid, each policy year, tax deferred. Exceeding this allowance is a chargeable gain. The gain is equal to the amount surrendered over the allowance.

The trustees have used all their allowance in previous years. They’ve just started a new policy year and have an allowance of £5,000 (5% of £100,000). If the trustees surrender £25,000 in this way, they will trigger a £20,000 gain (£25,000 - £5,000).

The trustees could consider repaying this portion of the loan by surrendering individual policies.

The bond is segmented into 1,000 identical policies. Each policy holds 1,000th of the premiums, surrender value, previous withdrawals and previous gains. For example, each policy has a premium of £100,000 / 1,000 = £100.

The gain on a segment is calculated by looking at the surrender value plus previous partial surrenders (£50,000/1,000 = £50), minus premiums paid and previous gains/excess events. Each policy has a surrender value of £70. For this particular bond, the calculation looks like this:

(£70 +£50) - (£100 + £0) = £20 gain per policy.

A surrender of 357 policies would realise a value a little under the £25,000 target.

357 policies x £20 gain = £7,140 total gain for the surrender.

Which option is best?

The settlor/lender is taxable for the gain of the discretionary trust during their lifetime. Unlike an onshore bond, there is no tax deemed to be paid within the underlying funds of the policy and your client will pay tax on any gain at their marginal rate of tax.

In this example, it would be better to surrender individual policies as the gain is £7,140 compared to £20,000 by doing a part surrender across all policies, helping to reduce the tax bill for your client.

However, this may not always be the case especially where your client has any unused tax deferred allowance. It will be necessary to calculate both methods to determine which is the most tax efficient method for your client. We do have a Chargeable Event calculator which will enable you to carry out the calculations.

 

2. Top slicing - working out the correct number of years.

Problem:

My client’s bond started on 1 February 2015. They have always been UK resident and took a partial surrender of their policy on 15 December 2019 which has exceeded the 5% tax deferred allowance (‘excess event’). There have been no previous excess events on the policy. How many years do I use for the top slicing calculation?

Solution:

For a UK resident individual, top slicing relief can reduce the income tax payable on a chargeable gain. It provides a relief against any higher or additional rate tax by comparing the tax on the full gain and the tax on the ‘average gain’. The average gain is calculated by dividing the full gain by the number of ‘relevant years’.

The number of relevant years depends on the type of chargeable event.

As there have been no previous excess events on your clients policy, the relevant number of years for top slicing is the whole number of policy years since the start date of the bond. A policy year begins on the start date of the bond and ends on the day immediately before that date in the following year.

The policy year for your client ends on 31st January. As the excess event happened on the policy anniversary date of 31 January 2020, the relevant number of years for top slice relief is 5 years.

If there have been previous excess events on the policy you can only go back as far as the last previous excess event.

So if your client had a previous excess event on 31st January 2018, then the relevant number of years for the 31st January 2020 event would be 2 years.

The guidance given above applies to both onshore and offshore bonds. However, for offshore bonds, it will only apply provided:

  • The bond started after 6 April 2013; or
  • The bond started before the 6 April 2013 and an additional premium has been paid since 6 April 2013.

If the offshore bond started before the 6 April 2013 and no additional premiums have been paid into the bond paid since 6 April 2013, you can use the full number of policy years since the bond start date.

 

Visit our chargeable events hub.

www.oldmutualwealth.co.uk/Adviser/literature-and-support/chargeable-events/

The hub includes; chargeable event gain calculator, income tax (top slice relief) calculator as well as our suit of quick reference material.

 

The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth or Quilter International's interpretation of the relevant law and is correct at the date shown on the title page. While we believe this interpretation to be correct, we cannot guarantee it. We cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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