19% Income Tax Cut Means More Investment Bond Tax for Higher Taxpayers
Published / Last Updated on 08/10/2022
Insurance investment bonds are another type of investment ‘wrapper’ with a set of tax rules that invests in markets in the same way that both ISAs and pensions are different tax ‘wrappers’ with different tax rules that invest in markets.
Insurance bonds are non qualifying life insurance investments that the investments fund growth pays gains taxes, and you only see net growth after this marginal tax rate.
You can withdraw up to 5% pa of the original capital with no immediate liability to income tax. If you withdraw more, you may face tax.
If fully or partially encash the bond, you may face taxes.
Bond Taxation
For example: you invested £20,000 in a bond 10 years and it now worth £40,000. You have made gain on £20,000. You then decide that you wish to cash in the whole bond i.e., £40,000
Top Slicing: Gain made of £20,000 over 10 years. That’s an average of £2,000 pa. This is known as “the slice”.
The £2,000 slice is added to your income this tax year.
Basic Rate Taxpayer 20%
- £2,000 slice + Your Income: If this total is below the higher rate tax threshold (£50,270). There is no tax to pay as you are deemed to have already paid basic rate tax.
- £2,000 slice + Your Income: If all the £2,000 gain slice is above the higher rate tax threshold (£50,270), 20% income tax is payable overall £20,000 (as it each £2,000 slice is deemed in the higher rate tax band). Higher Rate Tax is 40% but you are deemed to have already paid basic rate tax. 20% deemed paid, so 20% marginal (to take you up to 40%) is payable on the whole of the gain.
Higher Rate Taxpayer 40%
- £2,000 slice + Your Income: If all the £2,000 gain slice is above the higher rate tax threshold (£50,270), 20% income tax is payable overall on £20,000 gain (as it each £2,000 slice is deemed in the higher rate tax band). Higher Rate Tax is 40% but you are deemed to have already paid basic rate tax. 20% deemed paid, so 20% marginal (to take you up to 40%) is payable on the whole of the gain.
- £2,000 slice + Your Income: If some of the £2,000 gain slice is below the higher rate tax threshold (£50,270) e.g., £1,000 of the slice (half of the gain) in basic rate tax band and 20% basic rate income tax is deemed already paid. For the remaining £1,000 of the gain slice, 20% income tax is payable on this and therefore part of £20,000 i.e., £10,000 (as it is £1,000 of each slice is deemed in the higher rate tax band). Higher Rate Tax is 40% but you are deemed to have already paid basic rate tax. 20% deemed paid, so 20% marginal (to take you up to 40%) is payable on £10,000 of the gain. In summary, no tax is paid on £10,000 of the gain (deemed paid) and 20% is payable on the remaining £10,000 of the gain.
Additional Rate Taxpayer 40%
- £2,000 slice + Your Income: If all the £2,000 gain slice is above the additional rate tax threshold (£150,000), 25% income tax is payable overall on £20,000 gain (as it each £2,000 slice is deemed in the additional rate tax band). Additional Rate Tax is 45% but you are deemed to have already paid basic rate tax. 20% deemed paid, so 25% marginal (to take you up to 45%) is payable on the whole of the gain.
- £2,000 slice + Your Income: If some of the £2,000 gain slice is below the additional rate tax threshold (£150,000) e.g., £1,000 of the slice (half of the gain) in higher rate tax band with 20% basic rate income tax is deemed already paid so 20% is payable on £10,000 to take it up to 40%. For the remaining £1,000 of the gain slice, 20% income tax is deemed paid and therefore part of £20,000 i.e., £10,000 (as it is £1,000 of each slice is deemed in the additional rate tax band). Additional Rate Tax is 45% but you are deemed to have already paid basic rate tax 20%, so 25% marginal (to take you up to 45%) is payable on £10,000 of the gain. In summary, 20% is payable on £10,000 of the gain and 25% is payable on the remaining £10,000 of the gain.
Impact of 19% Income Tax Rate Cut.
- Bonds and taxable gains below basic rate (20%) threshold are deemed tax paid, no further tax payable and will be the same at 19% when income tax rate is reduced.
- Taxable gains, in the higher rate band (40%) currently have tax due at 20% (as 20% deemed paid) BUT when basic rate reduce then marginal rate tax due will be 21% (as 19% will be deemed paid).
- Taxable gains, in the additional rate band (45%) currently have tax due at 25% (as 20% deemed paid) BUT when basic rate reduces then marginal rate tax due will be 26% (as 19% will be deemed paid).
Conclusion
If you are a 40% or 45% taxpayer and you plan to encash or partially encash insurance investment bonds, you may wish to consider doing this now.
