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Technical: Chargeable gains and student loans

12 April 2021

What happens when an investment bond tax point is moved to a lower rate taxpayer, i.e. a student? There are implications, points out Kim Jarvis, technical manager, Canada Life.

One of the advantages of an investment bond is the ability to assign the whole bond or individual segments to another party without triggering a chargeable event, provided no cash changes hands.

Consequently, a higher rate taxpayer can move the tax point to a lower rate taxpayer and, provided the assignment is not for money’s worth, no chargeable event occurs.  Then going forward, if a chargeable gain occurs it is based on the new owner’s marginal rate of tax.

Where a bond is written under a discretionary trust, trustees can also move the tax point to a beneficiary. Again, this is not a chargeable event but, as it is a distribution from the discretionary trust, there may potentially be an inheritance tax liability.

When moving the tax point to an individual who has a student loan both the owner and trustees need to be mindful of the implications.

Case study

Take for example Jason and Sally who invested £200,000 into an onshore investment bond 10 years ago. The bond consists of 200 segments and is currently worth £500,000.  To date they have not taken any withdrawals from the bond.

Their son, Simon has been working for just over a year, earning £20,000, after finishing a 3-year university degree. Being more settled his parents would now like to provide him with some money for a house deposit.

As both Jason and Sally are higher rate taxpayers, they decide to assign some of the segments to Simon and provided he remains a basic rate taxpayer when he subsequently surrenders the segments, due to the 20% tax credit on an onshore bond gain there will be no tax to pay.  Jason and Sally decide to assign 20 segments to Simon, this will be a gift for inheritance tax purposes but provided both survive 7 years the gift will be outside of their estates.

Simon then surrenders the 20 segments receiving £50,000 creating a chargeable gain of £30,000.  Simon self-assesses for this chargeable gain but as the gain plus his income of £20,000 keeps him within the current basic rate band there is no further tax to pay.

However, not long after filling his self-assessment return he receives correspondence stating that he needs to start repaying his student loan as his income exceeds the repayment threshold.  Simon has a Plan 2 student loan so is aware that if his gross income is over £26,575 a year, he will need to start repaying the loan.

But his gross income is £20,000? So, what happened? The threshold is based on taxable income and although he had no income tax to pay on the chargeable gain, due to the 20% tax credit, it is treated as savings income. Therefore his “taxable” income for the year was £50,000 (his gross salary plus the chargeable gain), meaning that he now needs to repay some of his student loan.

He needs to repay 9% of the amount earned over the threshold, therefore Simon now needs to repay £2,108.25 ((£50,000 – £26,575) x 9%) to the government. Repayments are made automatically through the tax system and as Simon is employed the repayments will be taken directly out of his salary through the PAYE system. Effectively Simon would receive net proceeds of £47,891.75 after surrendering the segments.

So, what are the alternatives? Jason and Sally have not taken any withdrawals so instead of fully surrendering the segments Simon could have utilised the cumulated 5% tax-deferred allowance.  With the bond being in its 11th year Simon would have a cumulative allowance of £11,000 without triggering a chargeable gain.

In this case study Jason and Sally are still higher rate taxpayers at the point of assignment so if they had surrendered the 20 segments, they would have an extra 20% income tax liability to pay on the £30,000 chargeable gain.  Meaning that net proceeds for Simon would be £44,000 (£50,000 – £6,000 tax on the chargeable gain).  So, it would still be better to assign ownership to Simon before surrendering.

But if at the time of assignment Jason and Sally were basic rate taxpayers, instead of assigning the segments to Simon, they could surrender them and, provided they remain basic rate taxpayers after realising the chargeable gain, have no further tax to pay.  They could then gift the surrender proceeds to Simon, instead of the segments, to ensure that Simon receives the full £50,000.

Also, consideration could be given to the timing of the gift as individuals start to repay their student loans in the April after they finish their degree.  So, if Simon left his course in June 2020, even though he started work in September 2020 provided the policies were assigned and surrendered before April 2021 the chargeable gain would have no impact on the repayment of his student loan.

When dealing with clients who wish to provide funds for their adult children thought needs to be given to whether that child has a student loan. It will be too late after HM Revenue & Customs (HMRC) have assessed any self-assessment tax return submitted to them. So, while there is no certainty as to whether HMRC will ask for a repayment, it is helpful for individuals to be aware when they may be required to repay some of their student loan.

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