My wife, a non-tax-paying pensioner, holds some investment bonds in her name which she wants to cash in and gift the proceeds to our children. How do we calculate her tax liability and go about paying it?
Investment bonds are life insurance policies where you invest a lump sum in a variety of available funds. Some investment bonds run for a fixed term, others have no set investment term. When you cash investment bonds in, how much you get back depends on how well – or how badly – the investment has done.
Onshore (UK) investment bonds enjoy taxation advantages over other investments in that income paid out by the bond is deemed by HM Revenue & Customs to be net of basic rate income tax- hence the basic rate tax payer has no further tax to pay. I assume this is the situation for your wife. The funds themselves benefit from being free from capital gains and income tax, provided you are the owner of the investment bond.
It is possible to receive a regular income by taking withdrawals of up to 5% of the initial investment amount (for the first 20 years, or until the original capital invested is returned if withdrawals of less than 5% per annum are taken), tax deferred. This 5% per annum allowance of the original capital invested is cumulative- so if not used in one year can be carried forward to the next. Hence if you did not use your 5% allowance for the first three years of being invested, in the fourth year you could carry the unused three years forward and add it to the fourth year’s allowance, meaning 20% can be withdrawn with no immediate liability to income tax.
Unlike other investments, UK-based investment bond gains aren’t subject to capital gains tax or income tax unless the holder is a higher-rate (40%) taxpayer. This is because the insurer you took them out with has already paid corporation tax on income earned by the assets backing the bond, and capital gains tax on profits.
This is the equivalent to basic-rate tax. Although you don’t give the exact size of the gain on the bond, it is unlikely to take your wife’s income over the higher-rate tax threshold, so there will be no further tax for her to pay.
You can usually withdraw some or all of your money whenever you need to, but a surrender penalty might apply if you do so in the first few years. There might also be a tax charge. It should be possible to assign the bonds to your children instead of cashing them in, but in this case it won’t save on tax – as you might if your wife was a higher-rate taxpayer and your children basic-rate taxpayers.
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