Offshore bond top-slicing – the devil is in the detail

Advisers and clients could be caught unaware by a little-known change to offshore bond top-slicing, warns Rachael Griffin, financial planning expert at Old Mutual Wealth.

Offshore bond top-slicing - the devil is in the detail

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Top-slicing on offshore bonds in the UK is a well-known benefit, and can help a client apportion any gain over the life over their policy, thereby reducing the amount of tax which is due.

The current understanding among most advisers is that top-slicing can be carried back to inception.

However, due to a little known change in the rules, which took effect back in April 2013, a small number of clients will no longer be able to do this.

How it works

Top-slicing works, by taking the gain and dividing it by the complete number of years the bond has been in place, which creates a ‘slice’.

The slice is then added to individual’s income for the tax year to calculate the amount of income tax due on that slice.

If a client taking excess withdrawals continues to inadvertently top-slice back to inception then they will not be paying the correct amount of income tax on the withdrawal.

Rule change

When HM Revenue & Customs changed the time apportionment relief rules in April 2013, there was a consequential impact on the top-slicing rules on offshore bonds.

These changes have never been explicitly highlighted by HMRC and therefore have largely gone unnoticed by financial advisers.

In summary, the change means clients holding an offshore bond, taken out (or added to) on or after 6 April 2013, can no longer top-slice back to inception when calculating the tax payable on withdrawals exceeding the 5% deferred allowance (deemed an ‘excess event’).

Top slicing for final events (full surrenders, maturities and death) remain unaffected by these changes, and can continue to be calculated from inception.

Added complications

It is important advisers are aware of these changes. Even though the majority of their clients will be unaffected, and can continue to benefit from top-slicing back to inception, there will be a small proportion of clients who unknowingly won’t be able to do this – and the longer it goes on, the more complex the situation will become, as any unpaid tax liability increases.

Example

John takes 7.5% income each year from his offshore bond. Every year the 5% allowance is exceeded by 2.5%.

Previously, the longer the bond was in force the more years this excess gain could be sliced over.

This provided the opportunity to pay tax at a lower rate on the excess where the full excess moved the individual from basic to higher or higher to additional rate tax.

As John took out the offshore bond after 6 April 2013 the number of years on these excess gains is limited to one as the excess occurs each year.

If advisers have clients holding offshore bonds post 6 April 2013, who regularly exceed the 5% allowance, they should review the impact this change could have.

 

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