Module 7 – How to take money from the bond
Taking money out of the bondThis is module 7. Now we’ll look at how to take some of the money out of the bond. An individual may take money out of the bond at any time but this will lower its value. They can:
If the policyholder wants to take only part of the value of their investment, there are two methods of doing this. Each method has its own tax rules for calculating the gain.
Choosing the wrong method can lead to an unnecessary tax charge.
The methods for calculating the gain are:
Tax rules for partial withdrawals across all segments
It’s very important to realise that the gain on a taking proceeds can vary significantly depending on whether the money is taken as a partial withdrawal across all segments or by full surrender of individual segments. So it’s essential that you calculate the gain for both types of transaction before deciding on your method.
This is an example of how the money is taken from the bond.
Withdrawal across all segments - if each segment is £10,000, this bond has a surrender value of £100,000. A withdrawal of £20,000 means £2,000 is taken from each segment.
Full surrender of individual segments - if each segment is £10,000, this bond has a surrender value of £100,000. Taking £20,000 out means the bond is reduced by two segments.
Partial withdrawals across all segments
First, let’s take a look at partial withdrawals across all segments. This means an equal amount of money is taken from each of the segments to make up the amount. The formula for working out the gain on partial withdrawals across all segments is based on the 5% rule.
Below is the calculation for partial withdrawals across all segments after two years and also 20 years.
Year 1 premium= £100,000, 5% allowance = £5,000
Year 2 withdrawal= £70,000, 5% allowance = £10,000
Less (5% x 2) = £10,000
Gain= £60,000
Year 1 premium= £100,000, 5% allowance = £5,000
Year 20 withdrawal= £70,000, 5% allowance = £100,000
Less (5% x 20) = £100,000
Gain= Nil (allowance carrying into year 21 = £30,000)
Full surrender of individual segments
Let’s see how to calculate the gain using the full surrender of individual segments method. This means some of the individual segments are fully cashed in.
The formula for working out the gain on full surrender of individual segments is based on the current surrender value of the bond at the time the surrender is made.
Below is the calculation for full surrender of individual segments after two years and also 20 years.
Use the Formula - (surrender value + previous withdrawals) – (total premium paid + previous chargeable event gains) = gain
Example 1
Year 1 – Premium = £100,000, Segment allocation = 10 (each segment = £10,000)
Year 2, Surrender value = £200,000, Segment allocation = 10 (each segment = £20,000), withdrawal = £100,000
The surrender of five segments (5 x £20,000) = £100,000 + previous withdrawals (nil) =£100,000
Less
Original cost of five segments is (£100,000 x 5) = £50,000 + previous chargeable gains (nil) =£ 50,000
10
Gain = £50,000 liable for tax.
Example 2
Year 1 – Premium = £100,000, Segment allocation = 10 (each segment = £10,000)
Year 20, surrender value = £1 million, Segment allocation = 10 (each segment = £100,000), withdrawal = £100,000
The surrender of one segment = £100,000 + previous withdrawals (nil) =£100,000
Less
Cost of one segments is £100,000 x 1 = £10,000 + previous chargeable gains (nil) =£ 10,000
10
Gain = £90,000 liable for tax.
You’ve now seen examples for working out the gain for both partial withdrawals across all segments and full surrender of individual segments.
Each method is affected by time (how long the investment has been in the bond). The performance of the bond (growth on the investment, if any) is only taken into account in the calculation for full surrender of individual segments. The calculation for partial withdrawals across all segments doesn’t take into account the investment performance of the bond and so can lead to a highly artificial result. However, there are no simple rules to say what the best method will be.
Remember, you must use both formulas to see what gain is liable for tax and then make your choice.
Which method for taking money from a bond takes into account the current surrender value? You can find the answer at the end of this module.
Option 1 – Partial withdrawals across all segments
Option 2 – Full surrender of individual segments
How do the calculations compare?
Now that we’ve seen how to calculate the gain for either a partial withdrawal across all segments or for full surrender of individual segments, let’s see how they compare.
Take the example of a bond bought for £100,000.
Its current surrender value is £100,000.
It’s made up of 10 segments at £10,000.
Withdrawal of £80,000 made in year 2.
Partial withdrawal across all segments
Year 1 premium= £100,000, 5% allowance = £5,000
Year 2 withdraw= £80,000, 5% allowance = £10,000
Less (5% x 2) = £10,000
Gain = £70,000
Full surrender of individual segments
Surrender eight segments at £10,000 each = £80,000 (withdrawal) + previous withdrawals £nil = £80,000
Minus premium paid = £100,000 x 8 + previous chargeable gains (nil) = £80,000
10
Gain = £80,000 - £80,000 = £0
In the example on the previous screen, we saw how using the full surrender of individual segments calculation reduced the gain to zero. If, however, the partial withdrawals across all segments is used then the gain is far greater.
However, have a look at the following example where the tax liability for partial withdrawals across all segments is zero.
Take the example of a bond bought for £100,000.
It’s made up of 10 segments of £10,000.
Its current surrender value is £1 million.
The policyholder wants to withdraw £100,000 in year 20.
Partial withdrawal across all segments
Year 1 premium= £100,000, 5% allowance = £5,000
Year 20 withdraw= £100,000, 5% allowance = £100,000
Less (5% x 20) = £100,000
Gain = £nil
Full surrender of individual segments
1 segment x 100,000 per segment = £100,000
Minus 1 segment cost = £10,000
Gain = £ 90,000
Remember, when you’re calculating the gain on a withdrawal from a bond, you should consider the following criteria:
It’s important to try both calculations to establish which method of withdrawal generates the lowest taxable gain.
In which year does the gain arise?
The policy year begins on the day a policy is taken out and on the same date in subsequent years. The policy ends on the day before the anniversary of the start date.
Example for full surrender of individual segments:
Full surrender of rights, final participation in profits, death or maturity – all bring the insurance year to an end on that date. It’s then referred to as the final insurance year.
The date of surrender (1 April 2005) will fall into the tax year (2004-2005).
Example for partial withdrawals across all segments:
A policy taken out on 1 June 2004 has a policy year ending on 31 May 2005. If proceeds are taken on 1 April 2005, in the tax year 2004-05, any gain on a partial withdrawal across all segments would be treated as arising at the end of the policy year, in other words on 31 May 2005, and is consequently assessable for tax year 2005-06.
However, a gain on full surrender of individual segments on 1 April 2005 is treated as arising on 1 April 2005, the date of surrender, and is therefore treated as assessable for the tax year 2004-2005.
In this module you’ve learned:
Answers to questions in module 7
Question 1
Which method for taking money from a bond takes into account the current surrender value?
Option 1 – Partial withdrawals across all segments
Option 2 – Full surrender of individual segments
Answer
Well done if you selected option 2. The calculation for partial withdrawals doesn’t take into account the current surrender value whereas the full surrender of individual segments calculation uses the current surrender value at the time of the withdrawal.