For advisers with UK-resident clients who have made or may make gains on investment bonds that result in an income tax charge, there are several key considerations.
Chargeable gains on investment bonds can trigger income tax liabilities. But with some basic planning, the impact can be significantly reduced. In particular, relief at source pension contributions can play a powerful dual role: they extend income tax bands — potentially ‘absorbing’ gains that would otherwise be taxed at higher rates — and they benefit from basic rate tax relief.
Investment bonds are subject to income tax
Single premium investment bonds fall under the chargeable event legislation, which means any gains are subject to income tax, not capital gains tax (CGT). This can push tax rates up to 45%, swallowing nearly half of the investment gain.
UK-based (onshore) investment bonds offer some mitigation: a 20% tax credit is included in the gain, reflecting corporation tax already paid within the insurance wrapper. As a result, the bondholder is only liable for any higher (additional 20%) or additional (further 25%) rate income tax due.
There are several tax reliefs available to reduce the burden of chargeable event gains. One of the most commonly used is top-slicing relief, which divides the total gain by the number of complete years the bond was held. This ‘sliced’ or annualised gain is used to determine the appropriate tax rate, potentially avoiding higher or additional rate income tax that might otherwise apply.
Pension contributions help extend tax bands
Relief at source pension contributions receive an immediate 20% boost within a UK-registered pension scheme. For higher and additional rate taxpayers, there’s an added benefit: income tax bands are extended by the gross pension contribution amount.
For example, a contribution of £8,000 results in £10,000 being credited to the pension. This extends the basic rate band from £37,700 to £47,700, allowing more income to be taxed at just 20%. The same applies to the higher rate threshold, pushing the point at which 45% tax becomes payable further up the scale.
Smart planning can wipe out a tax bill on bond gains
By combining top-slicing relief with pension contributions, advisers can help clients avoid a higher rate tax charge — or even reduce their bill to £0 — on chargeable gains from investment bonds. Of course, the client must be eligible to contribute to a pension scheme, have enough annual allowance remaining and have the funds available (including potentially from the bond withdrawal itself).
Example 1: Avoiding additional tax on a bond gain
- Client income: £45,000
- Bond gain: £35,000 over five years (tax credit of £7,000 applied)
- Top-sliced gain: £7,000 per year
Without planning, the aggregate gain breaches the basic rate band, leading to an income tax bill of £1,230.
A relief at source pension contribution of £1,000 (£1,250 gross) would extend the basic rate band to £38,950, just enough to keep the aggregate gain within it.
New tax calculation:
- £12,570 personal allowance
- £38,950 basic rate band (with pension extension)
- £500 personal savings allowance
- Total before higher rate kicks in: £52,020
- Total income including aggregate gain: £45,000 + £7,000 = £52,000
The result? No additional tax due on the bond gain, and a bonus £1,250 into the client’s pension pot.
Example 2: Achieving a net £0 tax bill for a higher rate taxpayer
- Client income: £60,000
- Bond gain: £20,000 over five years (tax credit of £4,000 applied)
- Top sliced gain: £4,000 per year
Without planning, income tax after top slicing is £3,000, as the gain breaches the basic rate band, and the personal savings allowance offers only limited help.
A relief at source pension contribution of £6,000 results in a gross contribution of £7,500. This:
- Delivers £1,500 immediate tax relief to the pension scheme
- Extends the basic rate band by £7,500—enough to move £7,500 of income from the 40% band into the 20% band
- Saves a further £1,500 in income tax (20% of £7,500)
- Total tax saving = £3,000 — exactly enough to wipe out the original liability.
Make tax work for retirement, not against it
Paying tax on investment gains is often a sign that a client’s wealth has grown successfully. While some tax bills are unavoidable, strategic planning around pension contributions can add real value — helping clients fund their retirement while reducing or eliminating the tax impact of exiting an investment.
By weaving pension contributions into your client’s exit strategy, you can help them either avoid tax entirely or ‘soften the blow’ by receiving relief back directly or via their pension pot.
Shaun Moore is a tax and financial planning expert at Quilter.