Skip to main content
Search

Reducing gains via a relief at source pension contribution

Date: 06 April 2023

Who is this article for?

Advisers who have UK resident clients that have or may make gains on investment bonds which result in an income tax charge.

Key takeaways

Investment bonds are liable to income tax

Single premium investment bonds are taxed under the chargeable event legislation, which means chargeable gains are assessed to income tax rather than capital gains tax (CGT). This can result in gains being taxed at rates up to 45% losing almost half the ‘profit’. UK based/onshore investment bonds provide the bondholder with a tax credit of 20% of the gain compensating for the corporation tax suffered within the insurance wrapper. This results in a personal income tax liable to higher (further 20%) and additional rates (further 25%) only.

There are numerous reliefs available for chargeable event gains but the one we will focus on today is top slicing relief. This relief allows any gain to be divided by the complete years made over to provide an aggregate or annualised gain figure. This aggregate gain is used to calculate the tax on the full gain as if your client had made it each year owned to help avoid paying higher rates of income tax than they would normally pay.

For more information on the top slicing relief calculation visit our chargeable events hub. Quick reference guide 5 covers the calculation in full.

 

Pension contributions extend income tax bands

Although relief at source pension contributions receive immediate tax relief of 20% within a UK registered pension scheme, higher and additional rate relief is provided by extending income tax bands. This works by extending the basic rate and higher rate band by an amount equivalent to the gross (after 20% relief at source) pension contribution. For example, if £8,000 was paid into a relief at source scheme, £10,000 would be credited to the scheme and the basic rate band would be extended from £37,700 to £47,700. This allows more income to be taxed at 20% providing the additional 20% relief for higher rate taxpayers. The same concept exists for higher rate band i.e. the amount that can be earned before 45% is payable.

 

Basic planning can help to avoid a tax bill on a bond gain or provide a net £0 bill

Using the concepts of top slicing relief and extending income tax bands, simple planning can help your client avoid paying a higher rate of tax on a chargeable event gain. Your client must be eligible to make a relief at source pension contribution (and have sufficient annual allowance remaining) and have sufficient funds to make one. The proceeds from the bond withdrawal could of course provide some or all of the money.

We will look at two examples, the first an onshore bond gain and a simple way to avoid paying further income tax on the gain. The second, achieving a net tax bill of £0 on a bond gain for a higher rate taxpayer.

The examples use 2023/24 allowances and bands:

  • Personal allowance = £12,570
  • Basic rate band = £37,700

Example 1

Income: £45,000

Bond gain: £35,000 over 5 years (tax treated as paid £7,000)

 

Without any planning, this gain would incur income tax after top slicing relief of £1,230. This is because the aggregate gain of £7,000 (£35,000 / 5) breaches the basic rate band.

By making a relief at source pension contribution of £1,000 (£1,250 gross) this tax could be avoided whilst adding £1,250 towards retirement provision.

This works by extending the basic band by £1,250 to £38,950. This is sufficient for the aggregate gain of £7,000 to remain within the basic rate band:

Available allowances & bands

  • £12,570 Personal Allowance + £38,950 basic rate band + £500 Personal Savings Allowance =
  • £52,020 before higher rate payable on bond gain

Total taxable income including the aggregate gain

  • £45,000 income + £7,000 aggregate gain = £52,000

By recommending a relief at source pension contribution of less than the initial tax bill your clients could avoid paying any tax on the chargeable event gain made on a UK investment bond.

Example 2

Income: £60,000

Bond gain: £20,000 over 5 years (tax treated as paid £4,000)

 

Without any planning, this gain would incur income tax after top slicing relief of £3,000. This is because the aggregate gain of £4,000 (£20,000 / 5) is above the basic rate band. The Personal Savings Allowance is available in this example, but it is not sufficient to cover the gain in full.

By making a relief at source pension contribution of £6,000, immediate tax relief is applied to the scheme providing a gross contribution of £7,500. This provides a £1,500 tax refund into the pension scheme. In addition, the basic rate band is extended by the gross contribution of £7,500. This provides a further £7,500 of income liable at 20% instead of 40% providing a tax saving of £1,500 (£7,500 * 20%).

By recommending a relatively modest relief at source pension contribution, your clients could achieve a net tax position of £0 on a chargeable event gain made on a UK investment bond.

Summary

Paying tax on an investment is a sign that you have managed your clients’ money well. Sometimes the tax bill is inevitable, but you can add further value by providing a well-rounded exit strategy from the investment by combining with contributions towards their retirement provision. This can avoid tax or ‘soften the blow’ by receiving it back either directly (reducing tax on other income) or indirectly (applied to a pension scheme).

Additional Technical Support

If you have a question that was not covered online, our expert team would be pleased to help. Simply click the button below, fill in the form and our technical team will aim to be in touch within 48 hours, between 8.30am-4.30pm, Monday-Friday. Or call the team on 02380 726010.

Request a call back

The information provided in this article is not intended to offer advice.

It is based on Quilter's interpretation of the relevant law and is correct at the date shown. While we believe this interpretation to be correct, we cannot guarantee it. Quilter cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.