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!