Investment bonds and top-slicing: how a gain is taxed, and when it isn't
Onshore and offshore bonds, the 5% withdrawals that defer tax, chargeable events, and top-slicing relief: the rule that lets a ten-year gain be taxed as if spread over ten years, so a basic-rate taxpayer can pay nothing on an onshore gain.
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Investment bonds are life-insurance wrappers sold mostly through advisers, and their tax is unlike anything else in personal finance: no capital gains tax, no dividend tax year by year, and a single income tax event when the bond is cashed in, with a relief that can shrink it to nothing.
Onshore, offshore, and the 5% rule
An onshore bond's fund pays tax inside it, which HMRC treats as covering basic-rate tax on any gain; an offshore bond's fund pays no tax, so the whole gain is taxable on encashment. Either lets you withdraw 5% of the original investment a year for twenty years with no tax at the time: the tax is deferred, not cancelled, and is reckoned up when the bond is finally cashed in. That deferral is the point for someone who will be a lower-rate taxpayer later, in retirement.
Top-slicing
On encashment the gain is treated as income in that year, which would push a large gain into the higher bands. Top-slicing relief divides the gain by the complete years held, adds that slice to your other income to find the tax rate, and applies that rate to the whole gain. A £40,000 gain over ten years on £30,000 of other income is a £4,000 slice inside the basic band: for an onshore bond, whose fund already paid basic-rate tax, the tax due is nothing; for an offshore bond it is £11,946. Raise the other income to £50,000 and the slice crosses into higher rate: £7,460 onshore. The bond gain calculator applies the HMRC method rather than the simplified versions most explainers use.
When bonds make sense, and when they don't
They suit someone with ISA and pension allowances already full who expects a lower tax rate at encashment, or who wants to assign a bond to a lower-rate spouse or adult child (assignment is not a chargeable event). They rarely suit basic-rate taxpayers with unused ISA allowance, and offshore bonds need care with the year of encashment. Compare with the CGT calculator for a general investment account, where gains are taxed at 18% and 24% with a £3,000 exemption. The Hundred Summers app carries onshore and offshore bonds as wrappers and taxes withdrawals under these rules in the projection.
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