The With-Profits Bond Surrender
Elaine, 67, invested £80,000 in a with-profits investment bond eight years ago. The bond has a current surrender value of £92,000 but a market value reduction (MVR) of 12% would apply if she surrenders now. Her adviser notes the fund has a smoothed value of £104,000. Elaine wants to surrender the whole bond to fund a kitchen extension costing £35,000 and to gift £20,000 to her granddaughter. She is a basic-rate taxpayer with income of £22,000 a year. She asks whether she can take just part of the bond and whether the MVR applies to partial withdrawals.
1. Explain how the MVR works and whether Elaine can avoid it by taking a partial withdrawal.
Read the worked answer
A market value reduction (MVR) is applied by a with-profits fund when the underlying asset value has fallen below the smoothed (book) value. It protects remaining policyholders from those exiting taking more than their share. The MVR is typically applied on full surrender and often on partial withdrawals above a free allowance (commonly around 5–10% a year of the original premium, depending on the policy).
So Elaine cannot assume a partial withdrawal avoids it:
- Up to the free withdrawal allowance (often 5% a year, cumulative) may be taken without MVR or charge.
- Amounts above that may attract the MVR proportionately.
- The MVR is temporary - insurers remove it when asset values recover - so timing matters.
Judgement: rather than surrendering £55,000 at once and crystallising a 12% MVR (about £6,600 on the surrendered portion), she should check the free allowance, consider phasing withdrawals across tax years, and consider whether the kitchen can wait until the MVR is lifted. The smoothed value of £104,000 versus £92,000 surrender value shows the MVR is doing real damage to her capital.
2. Assess the tax treatment of the surrender and of the £20,000 gift, given her income.
Read the worked answer
Investment bonds are taxed as non-income-producing (chargeable event) policies. Gains are assessed under chargeable event rules:
- On full surrender, the chargeable gain is the surrender value plus any prior withdrawals, less the original premium. Here £92,000 − £80,000 = £12,000 gain (ignoring prior withdrawals).
- Top-slicing relief may apply because the gain arose over eight years: the gain is divided by the number of years, added to her income to test the rate, then relief given. With income of £22,000 and a top-sliced £1,500 a year, she remains a basic-rate taxpayer, so the gain is likely taxed at basic rate (or the insurer's notional tax credit may cover it).
- The £20,000 gift to her granddaughter is a potentially exempt transfer (PET) for inheritance tax. It is within her annual exemption (£3,000) only up to that amount; the excess is a PET that becomes exempt if she survives seven years. There is no immediate IHT charge.
Judgement: surrendering in one tax year stacks the whole £12,000 gain into one year; spreading withdrawals across two tax years can keep her within basic rate and use two annual IHT exemptions. The gift is sensible IHT planning but she should document it and consider whether her estate can afford the loss of capital.