Bond encashments are a regular source of PII claims.
IFAs repeatedly make mistakes on them and if in doubt should involve the client accountant to offset liability. Here is the latest news from HMRC, who also struggle with the complexity.
A policyholder who invested £100,000 might find that the bond is worth £110,000 2½ years later. If a partial encashment of £90,000 were made, under the “5% rules” this would give rise to a chargeable event gain of £75,000 - even though the real investment gain on the whole bond was only £10,000 at that time.
The way of avoiding this inequitable outcome would have been to encash whole policy segments rather than take a partial encashment. This would result in a chargeable event gain reflecting and proportionate to the true “economic” gain inherent in the encashed segments.
So, in this example, if the original bond was established as 100 segments, 82 of these would need to be encashed to provide the cash required of £90,000. This would only produce a chargeable event gain of £8,200, some £66,800 less than with the part surrender route.
Faced with these unacceptable tax bills, some investors who have been caught in this trap have taken legal action to challenge HMRC. Generally speaking these actions failed. But as a result two things happened:-
The chargeable event part surrender rules still apply. This means that a policyholder can still make a 5% tax-deferred withdrawal each year for up to 20 years or to the extent the 5% allowance is not used in one year it can be carried forward to the next. But there is still a risk that if a policyholder makes a large part surrender, a large “artificial” chargeable event gain may arise.