Spring Budget 2020 Life Policy Taxation

Published / Last Updated on 18/03/2020

Budget 2020 - Top Slicing Explained: Will I pay more tax on Life Insurance Investment Bonds?

Top Slicing is a term used to determine whether further tax is due for UK residents once an investment bond has been surrendered or partially encashed.

  • The gain on the policy (surrender value less original investment) is calculated.
  • This gain is split equally over the complete years the investment has been in force.
  • This gives what is termed the 'average gain'.
  • The average gain is added to your taxable income in the year of surrender.
  • If the combined taxable income and average gain takes you into the higher rate or additional rate tax bracket, the proportion of any gain above the threshold is the investment bond's taxable slice - the 'Top Slice' 
  • The Top Slice is multiplied by the complete years the investment has been in force - Taxable Gain
  • 20% basic rate income tax is deemed to have already been paid inside the fund, tax is therefore due on this taxable gain at 20% for higher rate tax payers (40% less 20% deemed paid) and 25% for additional rate tax payers (45% less 20% deemed paid).

However, HMRC argued that the WHOLE GAIN should be added to your income when doing the Personal Allowance test.  In normal circumstances for every £2 ‘income’ that you have above £100,000, then your 0% tax personal allowance is reduced e.g. £110,000 income = £10,000 over £100,000k, on a £2 over for £1 allowance reduction = £10,000/2 = £5,000 reduced personal allowance from £12,500 to £7,500.  This means even more of you income could be taxed at 40% and 45% and more investment bond top slice gains at 20% and 25%.

This was defeated in court despite HMRC arguing the case and now the Chancellor will make it law that the total chargeable gain cannot be added to income to perform any Personal Allowance reduction test.

Example: Gross Income £40,000pa + £90,000 chargeable gain from investment bond (made over 10 years meaning the slice is £90,000/10= £9,000pa TOP SLICE GAIN)

What HMRC Wanted – High Taxes

Personal Allowance Test (what HMRC argued for) - Personal Allowance Test £40,000 + £90,000 = £130,000.

Meaning £30,000 over the £100,000 meaning = £30,000/2 = £15,000 personal allowance reduction i.e. you have lost your personal allowance.

Top Slice Calculation: 

Income £40,000, nil personal allowance, meaning £37,500 taxable at 20%, 2,500 taxable at 40%.

Add £9,000 TOP SLICE GAIN – the whole 100% of the £9,000 TOP SLICE GAIN when added to income is in the 40% income tax bracket – i.e. 100% of the gain is taxable.

£90,000 gain is taxable in the 40% Band (i.e. 20% tax deemed to paid, 20% tax payable)

£90,000 X 20% = £18,000 tax due on bond gains + income tax as normal on other income

Budget 2020 Confirmed This Method

Personal Allowance Test - Personal Allowance Test £40,000 + £9,000 TOP SLICE ONLY

Meaning Total Income £49,000 i.e. No Personal Allowance reduction i.e. you have NOT lost your personal allowance.

Top Slice Calculation: 

Income £49,000, £12,500 personal allowance + £37,500 20% tax taxable band meaning 100% of the TOP SLICE GAIN IS WITHIN Basic rate band

Within 20% Basic Band – TAX is Deemed Paid on the TOP SLICE GAIN

Meaning i.e. 100% of the whole gain has no tax further to pay .

= £18,000 tax saved!

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