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Income Tax - Individual Taxation - Knowledge Direct


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The new 0% rate of tax on Savings Income

With effect from 6 April 2015 the starting rate of tax for savings income was reduced from 10% to a zero rate. In addition, the savings rate band was increased from £2880 per year to £5000 and the ability to claim tax free interest was introduced but what does this all mean to investors?

For anyone who has earned income of less than £15,600 per year they will be entitled to tax free interest on their savings up to the £15,600 limit, ie the £10,600 personal allowance and £5,000 savings income band.

Where total income including savings income is less than £15,600 in any tax year it is possible to register to receive interest on bank and building society savings tax free and avoid the need to reclaim the tax suffered.  In circumstances where the income will exceed £15,600 but an element is entitled to the zero rate it is not possible to register to receive interest tax free but the tax deducted can be reclaimed.

Example 1:

Steve has employment income of £12,000 and receives interest on his building society savings to the sum of £2000 each year.

As his earned income and savings income together do not exceed £15,600 not only is he entitled to the zero rate of tax on his savings but he can register to receive his interest tax-free.

Steve can register to receive his interest tax-free by making a claim to HMRC using form R85.

Example 2:

Joan has employment income of £14,000 and receives interest on her bank savings to the sum of £3,000 each year.

Whilst Joan is entitled to the zero rate of tax on £1,600 of her savings income she cannot register to receive this tax free because she has an element that is liable to tax at 20%. 

Joan can reclaim the tax suffered on the £1,600 by making a claim to HMRC using form R40

Benefits for Offshore Investment Bond holders

The increase in the savings income band and the introduction of the zero rate of tax is good news for offshore bond Investors. 

Gains from life assurance policies are treated as savings income within Chapter 9 of Part 4 Income Tax (Trading and Other Income) Act 2005, however, when considering the order of taxation, there is a hierarchy to consider.  Gains from onshore investment bonds are always taxed as the highest slice of income whereas chargeable gains arising from offshore bond investments fall within the “savings income” bracket and as such may fall within the savings income band.   

Order of Taxation:

Case Study 1:

Jonathan’s pension income is £10,000 and he wishes to supplement this by taking a regular withdrawal of £10,000 per year from his offshore investment bond. 

He invested £100,000 into his bond which would provide a 5% tax deferred allowance of £5,000 per year.  As his withdrawal will exceed this he will incur a chargeable gain of £5,000 each year. 

However, as the gain, when added to his pension income keeps his income under £15,600 he will have no tax to pay on the withdrawal:

Total Income:  £15,000 (£10,000 + £5,000)

 

Tax Rate

Tax to pay

£10,600

Nil

Nil

£4,400

@ 0%

Nil


If Jonathan’s pension income was £13,500 instead and he continued with his withdrawals of £10,000 per year from his offshore bond and incur a chargeable gain of £5,000 each year his tax liability would be:

Total Income: £18,500 (£13,500 + £5,000)

 

Tax Rate

Tax to pay

£10,600

Nil

Nil

£5,000

@ 0%

Nil

£2,900

@ 20%

£580

Case Study 2:

Frank is married to Karen and they have twin boys Joshua and Sam aged 19.  Frank inherited £500,000 14 years ago when his mother died which he invested into an offshore bond with Old Mutual International (Isle of Man) Ltd and his fund is worth £1,000,000 now.

Frank has decided that he would like to make annual withdrawals from his investment for Karen and the boys to provide Karen with a small income and to supplement the boys’ income whilst they are at University. 

Frank is a higher rate tax payer earning £75,000 per year; Karen only has a small income of £9,500 per year from her part-time job, the boys are also working part time whilst at University and each has a small income of £4,000 each year.

The original investment was split into 500 individual policies.  The most tax efficient way to withdraw capital is to assign individual policies to Karen and the boys prior to their encashment.  Frank decides to assign 4 policies to each of them in the tax year 2015/16.  He has made no previous withdrawals.

Chargeable gain per withdrawal of 4 policies:  £2000 - £1000 = £1000 gain x 4 policies = £4,000.

Tax liability for Karen:

Total Income: £13,500 (Taxable income £9,500; chargeable gain £4,000)

 

Tax Rate

Tax to pay

£10,600

Nil

Nil

£2,900

@ 0%

Nil


Tax liability for each of Joshua and Sam:

Total Taxable Income: £8,000 (£4,000 taxable income; chargeable gain £4,000)

 

Tax Rate

Tax to pay

£8,000 (within personal allowance of £10,600)

Nil

Nil


If Frank had withdrawn the proceeds from the 12 policies in his own name the tax liability would have been £4,800 (£12,000 chargeable gain x 40%). 

As an alternative Frank could have chosen to make the withdrawals as partial withdrawals across all policies within the 5% tax deferred allowance, however, as the proceeds are for the benefit of Karen and the boys and they can all take advantage of their personal allowances and the £5,000 savings income band this is the most tax efficient solution in this situation.  It crystallises the gain at the time of the withdrawal. 

These examples show that whilst chargeable gains may arise where withdrawals are made from offshore investment bonds careful consideration and planning can ensure that the withdrawals are as tax efficient as possible.

Gains from onshore bond investments cannot benefit from the savings income band because basic rate tax is already deemed to have been suffered within the investment and this cannot be reclaimed under any circumstances.

 

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