Welcome to BuyAssociation.co.uk

Tax after Retirement Fact Sheet

Top-slicing

The way gains on with-profits bonds are taxed when they are finally cashed favours higher-rate taxpayers who expect to move on to a lower tax band at retirement.

The so-called “top-slicing” rule makes deferring encashment until 65 an attractive proposition. This is because any liabilities are based on a taxpayer’s income at the time.

Tax is based on the profit the bond has made. This profit is then divided by the number of years a policy has been held to calculate the amount of annualised profit.

If the combination of the annualised profit and the taxpayer’s other income don’t take them into the higher 40 per cent bracket, there is no more tax to pay.

Where tax is payable, it is levied at 18 per cent on the so-called “top slice”, the amount over the higher tax threshold.

How top-slicing works

• Take a with-profit bond on which total gains have been £20,000 over a 20-year period

• Dividing the total profit by the number of years the policy has been running leaves an annual profit “slice” of £1,000. This £1,000 is then added to the investors’ current taxable income at the time of encashment

• If total income plus any top-sliced gain remain below the 40 per cent tax threshold no further tax is payable. This is because the with-profit fund in which the bond invests is already taxed at the basic rate

• Should some, or all, of that annual gain take total earnings above the higher rate income tax threshold, an additional 18 per cent will be charged on the portion over the limit – the so-called “top-slice”. This is then multiplied by the number of years the policy has been in force to give the final bill

Take someone with a total annual retirement income of £32,000. The £1,000 annual profits “slice”, described above, would still keep that taxpayer below £39,825, when the 40 per cent limit would otherwise kick in, leaving no tax to pay at all.

Clearly, the biggest gainers are those who were on a higher rate of tax while still working, but who have move to a lower income in retirement. Those on basic rate tax avoid paying extra tax. But those who pay little or no tax have nothing to gain from this ruse.

Please note, that you should never invest for tax reasons only, but only if an investment is suited to your specific needs.

Warning

In recent years, with-profit investments have come under waves of criticism for their opaqueness and poor performance.

In some ways this is a little unfair: all investment products have suffered in the wake of the stock market’s collapse.

However, it is true that with-profits products have their own particular problems. In many cases with-profits bonds do not set out their real charges.

Also, the manager has absolute discretion as to how what proportion of the fund should be invested in each asset class.

For example, until two or three years ago a typical with-profit fund invested 60-65 per cent of its money in shares, about 20 per cent in property and the rest in fixed-interest investments such as gilts and corporate bonds.

Today, the proportion of shares held in a with-profits fund holds about 40-50 per cent in shares and the rest in the two other remaining asset classes. This has two implications for investors:

1. The long-term performance of with-profits funds may be weaker;
2. You are in the hands of a manager who could do a swift U-turn in terms of investment strategy without you knowing about – until well after the event.

The lesson to draw is that you should always consult with a good independent financial adviser if you want to invest in this product.

More pages

Page 1: Introduction
Page 2: Top-slicing

Free delivery on office supplies everything from stationery to office furniture

Get Your Website On The First Page Of Google On A Budget FREE website health check and white paper on SEO in a recession

Document sharing - share, edit and save documents Secure document collaboration made easy!

Free ink cartridge click here new customers can order an ink cartridge for £0

Click here for a free consultation - make foreign exchange work for you