Top-Slicing Relief: Explained

In this guide, we’ll explain how top-slicing relief works, what affects it, and how to calculate it. Additionally, we’ll offer clarity on who can benefit from it and when it may not apply.

What Is Top-Slicing Relief, and How Does It Work?

Due to their tax-deferred status, life insurance policies and investment bonds are subject to distinct tax treatment. Rather than incurring annual tax on investment gains, tax becomes payable only upon a chargeable event.

As a result, the investment growth accumulated over the life of the policy or bond is taxed in the tax year when the chargeable event occurs.

This approach allows some expats to defer tax payments until retirement, when their overall taxable income is likely to be lower.

However, chargeable event gains can sometimes move taxpayers to a higher tax rate band. In such cases, top-slicing relief may be available.

This relief spreads the gain over the investment period, allowing the tax liability to be calculated as if the gain had been received in equal portions each year, potentially reducing the overall tax rate applied.

Due to the potential interaction with the personal savings allowance, nil-rate band, and the starting rate for savings, the relief could also apply even if the gains don’t move the taxpayer into a higher tax bracket.

Top-slicing relief is available only to individuals. Companies, personal representatives, or trustees can’t utilise it to reduce the amount of tax due.

How To Calculate Top-Slicing Relief

Calculating top-slicing relief is a complex process that should ideally be conducted by a professional to reduce the probability of miscalculations or potential fines. Nonetheless, it typically involves calculating the following:

1. The total taxable income for the year.
2. The total tax due on the gain across all tax bands.
3. The annual equivalent of the gain.
4. Your tax liability on the annual equivalent.
5. The top-slicing relief.

The Total Taxable Income for the Year

Calculate the total taxable income for the year and determine how much of it is covered by the following:

• Personal allowance (PA): Tax-free PA is £12,570. It is gradually reduced by £1 for every £2 you earn over £100,000. If your income is £125,140 or above, you are not entitled to any PA.
• Personal savings allowance (PSA): It represents the total interest you can earn per tax year without incurring taxes. Basic rate taxpayers are entitled to a £1,000 allowance, while higher rate taxpayers receive £500. PSA does not apply to additional rate taxpayers.
• Starting rate for savings band (SRSB): It permits you to earn up to £5,000 in savings income without being liable for tax and is determined in relation to your PA. If your non-savings income is equal to or higher than £17,570 (£12,570 of PA + £5,000 of SRSB), you can’t utilise SRSB. Your SRSB is reduced by £1 for every £1 of non-savings income above the PA.

The Total Tax Due on the Gain Across All Tax Bands

Individuals liable for tax under the chargeable event regime are typically considered to have already paid tax at the basic rate of 20% on their gains.

Since this tax is non-refundable, it should be deducted from the total tax liability to prevent double taxation. The rule applies to both offshore and onshore bonds.

The Annual Equivalent of the Gain

Divide the total gain by the number of years the policy has been held or since the last chargeable event. HMRC marks this period with the letter N.

Calculating N varies between offshore and onshore bonds and is contingent upon the specific type of event, such as excess events (including withdrawals, partial surrenders, or assignments) or full surrenders.

Calculations will also differ if the bond or life insurance policy is susceptible to regulations effective prior to 6 April 2013.

Calculations for onshore bonds are straightforward:

• Excess events: N refers to the number of whole policy years since the bond’s start date (if it’s the first excess event) or last excess gain (if there were excess events in the past).
• Full surrenders: N refers to the number of whole policy years since the bond’s start date.

Calculating N for offshore bonds is more complicated because of legislative changes introduced on 6 April 2013, and there are several scenarios to consider:

Note that time apportionment relief (TAR) may affect how you calculate N if you were a non-UK resident during part of the bond’s holding period. In such cases, N should be reduced by the number of years you were not a UK resident.

Your Tax Liability on the Annual Equivalent

How you’ll calculate liability depends on when the gains arose:

• For gains arising in 2018/2019 onwards: The PA is recalculated by aggregating the total income for the relevant tax year with the sliced gain—the annualised portion of the total gain. Gains realised in earlier tax years are not eligible for a recalculation of the personal allowance. Where the recalculated total income is less than £100,000, the full PA remains available.
• For gains arising in 2021/2022 onwards: The PSA and the starting rate for savings are recalculated based on the total income for the tax year, including the sliced gain. Gains that arose in previous tax years aren’t eligible for PSA and SRSB recalculations. If the recalculated income is within the basic tax rate band, the available PSA is £1,000. If it is within the higher rate band, the available PSA is reduced to £500.

Deduct the basic rate tax treated as paid on the sliced gain (annual equivalent) and multiply it by N to calculate your relieved liability.

The Top-Slicing Relief

You’ll calculate the amount of top-slicing relief due by subtracting your relieved liability (from step four) from your total tax liability (from step two).

To better illustrate how top-slicing relief works, consider an expat earning £32,700 who cashes in an onshore bond worth £160,000. This would increase their total income to £192,700, eliminating their personal allowance and savings reliefs.

Without top-slicing relief, the expat would be liable for £72,918 in income taxes, £34,378 of which would be attributed to the bond gains.

Utilising top-slicing relief, the £160,000 gain is averaged over eight years (£20,000 per year), which lowers the annual income and reduces the tax on the bond to £3,088, resulting in a top-slicing relief of £31,290.

With top-slicing relief, the income tax liability descends to £41,628.

How Can Expats Benefit From Top-Slicing Relief?

Some of the primary benefits of utilising top-slicing relief are:

1. Lowering annual tax liability
2. Providing more capital for future investments
3. Helping with retirement planning
4. Improving cash flow during low-income years

Lowering Annual Tax Liability

Instead of taxing the full gain in the year the policy is encashed, top slicing relief reduces the effective tax rate on gains by recalculating the tax as if the gain had been earned evenly over the years the bond was held.

Although the entire gain is taxed in the year of surrender, this relief can significantly lower the resulting tax liability.

Providing More Capital for Future Investments

Top-slicing relief reduces the immediate tax burden, effectively increasing the after-tax capital available for investment. This allows you to allocate the remaining funds into a broad range of investment opportunities to diversify your portfolio and further grow your wealth.

Helping With Retirement Planning

By averaging gains over the policy term, top-slicing relief allows expats to strategically align their bond or life insurance policy withdrawals with their other sources of retirement income, like pensions or annuities.

This can prevent their total taxable income from exceeding the higher tax bracket thresholds, effectively reducing overall tax liability and preserving more wealth.

Improving Cash Flow During Low-Income Years

Utilising top-slicing relief can significantly enhance cash flow in years when income is temporarily reduced, such as during early retirement, career transition, or parental leave.

The additional liquidity can be used to cover essential living expenses, education costs for children or grandchildren, or a relocation for work or repatriation.

For self-employed expats, additional liquidity can help sustain operations during downturns or fund a business expansion.