Act Now to Reduce Surrender Tax Charge

If you have surrendered a With Profits Bond during the current tax year and there's higher rate tax to pay on the gain, you only have a few days left to mitigate your tax bill.

Surrendering an Investment Bond creates a Chargeable Event and probably a Chargeable Gain. To see if higher rate tax is due you divide the gain by the number of years you held the policy and add that "top slice" to your taxable income. If you are a higher rate tax payer, or if this top slice makes you a higher rate tax payer, you will have an additional 20% tax to pay on that gain.

However, making a pension contribution in the same tax year means that effectively you get the usual tax relief of a pension PLUS you might be able to avoid paying the extra tax on the gain.

For example, imagine you have taken advantage of a 10th Anniversary No MVR Guarantee on a With Profits Bond where you invested £20,000 in 1999 and received back £30,000; a gain of £10,000. The £10,000 gain divided by 10 years means that the top slice to add to income to see if higher rate tax is payable is £1,000.

We'll assume your taxable income is at the cusp of paying higher rate tax (£40,835 in the 2008/9 tax year) so the £1,000 top slice is all assessable to higher rate tax, making a tax bill of £2,000 (£10,000 gain X 20% extra tax).

Rather than write a cheque for £2,000 to HMRC, you might be able to write a cheque to your own pension fund of just £800. This is grossed up by 20% basic rate tax to make a £1,000 gross pension contribution.

By making a £1,000 gross pension contribution you reduce your taxable income by £1,000. So when that £1,000 top slice of income is added to your taxable income you stay within basic rate tax band and there's no tax bill to pay on the gain.

In this case it's either £800 in your pension savings plan grossed up to £1,000, or pay £2,200 in tax. I know which I'd rather do!

Realistically your pension company will need your application and cheque by Friday 3rd April. If you've surrendered a bond this year and there's higher rate tax to pay, there's no time to waste!

Smooth as Ice

My Moneyfacts March 2009 magazine arrived this morning with fresh quarterly data on the performance of With Profits Bonds. To my knowledge Moneyfacts is the only magazine to provide performance data on With Profits Bonds that includes the Market Value Reduction (MVR) and actual surrender values. The surrender value after applying the MVR represents the policyholder's fair share of the fund, and allows you to assess how companies are smoothing returns.

I provided a fairly detailed analysis on my website last month explaining how a comparison between Distribution Bond performance and With Profits Bonds performance can give you a good insight into how returns are being smoothed. You can read more about that analysis here: http://www.withprofitshealthcheck.com/news

I've updated my figures for the same five insurance companies (Axa, Legal & General, Norwich Union, Prudential and Standard Life) and the results show that as at 1st February 2009 With Profits Bonds appear to still be smoothing returns. This is intimated by the fact that despite similar asset mixes in the funds, the With Profits Bonds are paying back more to clients who surrender today than for policyholders in the Distribution Bonds.



The point about smoothing is that it protects investors who are surrendering their investments after a sharp fall in the value of investments. It works by holding back some of the returns when times are good. So investors who surrender today could benefit.

Please note that past performance is not a reliable indicator of future returns and that this blog is for information only. Before taking any action you should consult an Independent Financial Adviser; if you don't have an IFA please get in touch and I'll be pleased to help.