How to take cash tax efficiently from an offshore bond (2024)

Key points

There are two ways in which money can be withdrawn from an offshore bond
Partial surrenders and full surrender of segmentscan give very different tax results
Client circ*mstances, investment performance and investment period will determine the most suitable option
Understanding how each method works can allow investment profits can be extracted most tax efficiently

Jump to the following sections of this guide:

Options for taking withdrawals
- Part surrender across all segments
- Full surrender of segments
- A combination of full and part surrender
Taxing the gain
Tax planning considerations
- Reasons for taking a lower gain
- Reasons for taking a higher gain

Options for taking withdrawals

Most offshore bonds are made up of a number of identical policy segments, typically between 100 to 1,000. Sometimes more. This structure facilitates a choice in the way cash can be taken if the whole bond is not being surrendered.

Once a client has decided how much cash they need, this can be provided by either:

taking equal amounts of cash from each policy segment, known as a partial or part surrender, or
the full surrender of policy segments.

The calculation of the gain under each method is very different:

Part surrender across all segments

By taking cash in this way, any gain has no link at all to investment performance; the gain is purely an artificial one.

This is because the calculation is simply: Gain = Amount withdrawn - cumulative 5% tax deferred allowance

Several important things to note here:

Clients can take up to 5% of their original investment tax free each year until they have had their original investment back. Any unused portion carries over to the next year. If they stick within this allowance, then there will be no chargeable event and therefore no gain.
A gain will arise if they exceed this allowance, but the test will always be at the end of a policy year, and this is when the chargeable event will happen. This could actually be in a different tax year from the one in which the cash was actually taken.
Tax deferred amounts will eventually be included in the final calculation when the whole policy, or individual policy segments, are cashed in.

Example

James invests £100,000 on 1st June 2020. This gives him 100 segments at a cost of £1,000 each.

On 1st March 2024 he needs to make a withdrawal of £75,000 towards the purchase of a new holiday home.

The surrender value for the whole policy on this date is £125,000. No previous withdrawals have been made.

If James takes his money by a part withdrawal:

Full surrender of segments

The key point about cash being taken in this way is that any gain will be directly linked to actual investment performance. So if profits are high, gains will be high. And vice versa.

First calculate the gain on each segment:

Chargeable gain = (value of segment + previous part surrenders from segment)-(amount invested in segment+ taxable gains on previous part surrenders)

The total gain will simply be the gain per segment multiplied the number of segments being surrendered.

Example (continued)

To get £75,000, James must therefore surrender 60 segments (75,000/1,250)
Per segment, the surrender value is £1,250 and at a cost £1,000. A gain of £250 per segment
So the total gain will be 60 x £250 = £15,000
This will be taxed in the 2023/24 tax year
Going forward, James is left with 40 segments, each worth £1,250 with a total value of £50,000

A combination of full and part surrender

So far, our example has produced a gain of £55,000 for a part surrender and £15,000 for a full surrender.

It's possible for the gain to be reduced even further by taking cash under a combination of withdrawals.

Example (continued)If James surrenders 53 segments:

this will give him £66,250 (£1,250 x 53), and a gain of £13,250
he will be left with 47 segments. He has a cumulative tax deferred allowance on these of up to £9,400
he only needs £8,750 to make up the £75,000. By taking this as a part surrender, the gain will reduce to £13,250 and he will still have an unused allowance of £650 to use in future years (£9,400 - £8,750).

Tip - the example shows how the ‘gain' can differ even though the same amount is taken from James' bond. But remember, it may not always be a surrender of segments that produces the smaller gain. For example, good returns and therefore high profits may mean that a part surrender will produce a smaller gain, particularly where the bond has been running for a number of years and no previous withdrawals have been taken.

The ultimate choice will largely depend on the potential tax bill, both now and in the future.

Taxing the gain

Gains are subject to income tax, and sit on top of all other income, apart from dividends and onshore bond gains, in the tax computation.

For an offshore bond, tax could be payable at any or all of the 0%,20%, 40% and 45% rates. ‘Top slice' relief, which broadly taxes the average gain over the whole investment period, may limit or even eliminate the amount of tax payable at the higher 40% and 45% rates

Equally, if other income is negligible or even non-existent, part of the gain may fall into the personal allowance, the savings rate band, and/or the personal savings allowanceand escape income tax altogether.

Example (continued)James decides to take his £75,000 as a full surrender of segments on 1st March 2024

This means the chargeable event occurs in the 2023/24 tax year. Had he taken the cash by part surrender on the same date, the chargeable event would not have happened until 31st May 2024, that is, in the 2024/25 tax year.

In 2023/24 he has other taxable income comprosed of salary and savings interest (after deduction of reliefs and allowances) of £35,000. The tax is worked out as follows:

Adding the gain of £15,000 to £35,000 takes total taxable income to £50,000.
This means his taxable income exceeds the basic rate band for 2023/24 of £37,500.
Top slice relief is available to reduce or eliminate tax at 40%.
The ‘sliced' gain is £5,000 (15,000/3 years). When this is added to other taxable income, the total taxable income is £40,000. £2,500 falls into the basic rate band and £2,500 falls into higher rate.
The amount taxed at 20% is £15,000 x £2,500 / £5,000 = £1,500
The amount taxed at 40% is £15,000 x £2,500/ £5,000 = £3,000
So, total tax due is £4,500

TIP - Consider surrendering the required number of segments either side of the tax year. This may reduce or eliminate the higher rate tax liability.

BUT, how much would the tax bill have come to if James had taken his cash as a part withdrawal? The first thing to note here is that the chargeable event is now in the 2024/25 tax year, and there will also be an additional year for top slicing.

Example (continued)

Let us assume that his taxable incomeincreases £35,200.

By adding the gain of £55,000 to taxable income, this takes his total taxable income to £90,200 which exceeds the basic rate band for 2023/24 of £37,700
This time, the sliced gain is £13,750 (£55,000 / 4 years). When added to other taxable income, £2,500 falls into basic rate, while £11,250 falls into higher rate.
The amount taxed at 20% is £55,000 x £2,500/ £13,750 = £2,000
The amount taxed at 40% is £55,000 x £11,250 / £13,750 = £18,000
So, total tax due comes to £20,000

This is £15,500 more than the full surrender of segments route.

TIP - there may be certain clients who wish to retain the maximum number of segments possible. For example, a higher rate taxpayer who is relying on the annual 5% tax deferred withdrawals to supplement their income.

Tax planning considerations

The best solution for each client will depend on individual circ*mstances. For many, the smallest gain will be chosen because this will result in the lowest income tax bill, as the above example shows. But there are other factors at play which may mean a higher gain is preferred to a lower one.

Reasons for taking a lower gain

To minimise the immediate tax bill. An extreme example; a bondholder finds they need a large withdrawal of cash for an unplanned cost early into the bond term. At this point, there is less likely to be much investment growth and so withdrawal by surrender of segments is likely to produce a relatively low gain. Conversely, there has not been much time for the 5% cumulative tax deferred allowance to build up, and so a part withdrawal may create a much larger gain
Many individuals are likely to belower rate taxpayers inretirement, so it makes sense to delay the tax charge until then. The same reasoning would apply where the intention is to assign the bond to a lower rate taxpayer sometime in the future
To avoid the loss of personal allowance. For the current tax year (2024/25), a taxpayer will lose all of their personal allowance once their ‘adjusted net income' (ANI) exceeds £125,140. Broadly, ANI is total income from all sources, including the full gains (not top sliced) from investment bonds. The personal allowance is worth £5,028 pa to a higher rate taxpayer
To avoid the child benefit tax charge. The value of child benefit is wiped out once ANI exceeds £60,000. If ANI can be kept below £50,000 including the full bond gain, this tax charge will be avoided

Reasons for taking a higher gain

If an individual is likely to bea higher rate taxpayer in the future. This may be because they are still working and anticipating a pay rise or perhaps a large bonus.
An increasing number of individuals can manipulate their income using pension freedoms. They could turn off their pension income in a tax year, cash in their bond and live off the proceeds, maybe escaping tax altogether if the gain falls within their tax free allowances. Gains of up to £18,570 could be taken in the current tax year completely tax free. And crystallising gains at a time when no tax will be payable can mean the eventual gain on final encashment is reduced.

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