Yesterday HMRC issued a consultation paper on part surrenders, addressing the inequitable tax consequences which can arise if customers withdraw money from their bond in the wrong way. HMRC is consulting on three new proposals, all of which will impact all UK and offshore bonds. Not all the proposals are attractive, with two of the proposals potentially complicating the situation further. The 100% allowance proposal seems the easiest to understand, and could help make bonds more appealing by offering increased flexibility.
The review by HMRC follows the case of Mr Lobler, who withdrew money from across all policy segments (rather than by a complete closure of individual policy segments) and suffered a significant tax liability. The Government said it would review the rules to prevent such extreme tax consequences arising which are completely disproportionate to the growth received on the investment.
The three new proposals set out by HMRC are as follows:
Taxing the economic gain
This option looks to calculate the economic gain on each withdrawal by treating some of the withdrawal as premium and not treating it all as gain. This therefore ensures the amount of tax chargeable is an appropriate fraction of the policy’s economic gain.
The 100% allowance
This will replace the current allowance for someone to withdraw 5% tax free each year. The 100% allowance will enable someone to withdraw any amount at any point, up to 100% of their premium before being liable to tax. Once someone withdraws 100% of premium, excess withdrawals are then taxed as economic gains.
Deferral of Excessive Gains
This involves keeping the current process in place, but including a benchmark for what is deemed an acceptable level of gain (e.g. 3%). So if large sums are withdrawn, a safety net kicks in to ensure no disproportionate tax consequences occur, and the gain rolls on to the next withdrawal point. If the gain is still excessive, it will roll on again, and so on, up to maturity or full surrender.
Comment by Rachael Griffin, financial planning expert at Old Mutual Wealth
“There has been much anticipation in how HMRC will amend its rules to address the inequitable outcome a customer may face if they take a withdrawal from an investment bond in the wrong way. It was hoped that HMRC would give sanctions to providers to simply correct such cases, as this only impacts a small percentage of policyholders (HMRC quote 600 cases). However, HMRC appears to be looking for a more robust process and wants to change the calculation basis for all partial surrenders.
“Two of the proposals; taxing the economic gain and deferral of excessive gains, both require complex calculations, and will impact all customers looking to make a withdrawal from their policy. It will make the withdrawal process more complicated and given some customers don’t fully understand today’s process I would argue it doesn’t help solve the issue
“The simplest of the three options proposed is the 100% allowance. Customers are already familiar with the 5% withdrawal allowance on bonds, so a 100% allowance would be easy to understand and does not require any additional complex calculations. It could also benefit customers as it would provide them with increased flexibility to withdraw over 5% a year if required, without creating any tax liability."
There are two ways in which a customer can withdraw money from an investment bond; they can either make a partial withdrawal from all policy segments or they can do a complete closure of individual policy segments. The way a customer is taxed in each scenario can be significantly different, and often the customer is unaware of the implications.
As a general rule of thumb, it may be more tax efficient to withdraw money (over and above the annual 5% allowance) through surrendering individual policy segments rather than taking the money through a partial surrender across all policies. However, each case needs to be reviewed on its own merits.
If a customer asks for money to be withdrawn from across all policies, where this is in excess of their 5% tax deferred allowance, the customer could be faced with a significantly greater tax liability than would have otherwise been the case. Mistakes can happen and may lead to extreme tax consequences which are completely disproportionate to the growth received on the investment. This is what has prompted the review by HMRC.