You can withdraw up to 5% of the premiums paid into an investment bond each policy year without an immediate tax charge, and any unused 5% carries forward, up to a lifetime total of 100% of the premium over 20 years. The tax is deferred, not removed: withdrawals are counted again when the bond ends. Taking more than the accumulated allowance creates an excess event, and the taxable gain is the excess itself, which can be far larger than any real profit on the bond.
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What is the 5% rule?
The rule is in section 507 of the Income Tax (Trading and Other Income) Act 2005. At the end of each insurance year in which there has been a part surrender, the insurer compares the total withdrawn with the allowable payments. HMRC’s manual at IPTM3560 sets the allowance for each premium as the premium multiplied by y/20, where y is the number of insurance years, up to 20, from the year the premium was paid to the year of the calculation. One twentieth is 5%, which is where the name comes from.
HMRC is explicit that this is not an exemption. IPTM1510 describes it as a deferral rule: tax on withdrawals within the allowance is postponed until the bond matures or is surrendered. IPTM7615 suggests it is better called the 5% tax deferred rule to make clear the allowable payments are not tax free. On a final surrender, everything previously withdrawn is added back into total benefits under the chargeable event gain formula.
How do unused allowances build up?
Unused allowances carry forward. IPTM7615 explains that for a single premium bond the facility to withdraw continues until either the 5% has been used for each of 20 years, or, after more than 20 years, total withdrawals exceed the premium. A further premium starts its own 5% allowance from the year it is paid.
HMRC’s example at IPTM7620 shows both features. A £10,000 premium is paid in January 2011, £500 is withdrawn in year 2, a further £5,000 premium is paid in February 2013 and £4,000 is withdrawn in year 5. By year 5 the allowances are 5 years at 5% of £10,000 plus 3 years at 5% of £5,000, a total of £3,250. Withdrawals of £4,500 exceed that by £1,250, so there is a £1,250 gain at the end of that insurance year.
The helpsheet HS320 gives a simpler case. A £10,000 bond started on 25 May 2019. In the insurance year to 24 May 2025, £3,700 was withdrawn and nothing before. Six years of allowance at £500 is £3,000, so the gain is £700, arising on 24 May 2025 and taxable in 2025 to 2026.
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When does an excess event arise and in which tax year?
If the periodic calculation shows withdrawals above the allowances, an excess event is treated as happening on the last day of the insurance year (IPTM7615). The insurance year runs from the policy start date, not 6 April. HS320’s example is a policy started on 1 July 1997: a withdrawal on 31 January 2025 creates a gain on 30 June 2025, taxable in 2025 to 2026, not in the tax year when the money was taken.
Two further points apply:
- Allowances already used are reset. After an excess event, the next calculation only counts withdrawals and allowances since that event (IPTM3560).
- No excess event in the final year. If the bond is fully surrendered in the same insurance year, the withdrawals are swept into the final calculation instead (IPTM7615 and HS320).
Loans from the insurer to the policyholder are treated as part surrenders and count against the allowance (IPTM3545).
Why do large part surrenders cause problems?
IPTM7615 states that the gain on an excess event is simply the amount of the excess and is not related to any increase in the value of the policy. A gain can arise even when the bond is worth less than was paid in. That produces results that look absurd:
- In HMRC’s Example B at IPTM3597, £100,000 is invested and £15,000 withdrawn in the first year. The allowance is £5,000, so the gain is £10,000 with a £2,000 tax charge, although the real gain on the part withdrawn was £295.
- In Example A, £206,000 was withdrawn from a £300,000 bond within its first year. The excess event gain was £191,000, producing income tax of over £70,000, against a real gain of £1,500.
The tax is due straight away. Relief comes later, if at all, through deficiency relief when the bond ends, and HS320 explains that this only reduces tax at higher rates and not at the additional rate. The full gain also counts as income for the Personal Allowance taper and, as HMRC’s Example E notes, can lead to the withdrawal of child benefit. Top slicing relief helps less than people expect, because on a UK bond a gain on an excess event is sliced only over the years since the later of the start of the policy and the last calculation event.
Is it better to surrender whole segments than take a part surrender?
Most bonds are issued as a cluster of identical policies, often called segments. IPTM1510 notes that the tax result of a withdrawal can be quite different depending on whether it is taken as a part surrender across all the policies or as the full surrender of some of them, and that it is the policyholder’s responsibility to understand the choice.
Illustration only. A £100,000 bond is split into 100 segments of £1,000. Early in year 2 it is worth £105,000, so each segment is worth £1,050. The owner needs £30,000.
| Method | Calculation | Taxable gain |
|---|---|---|
| Part surrender of £30,000 across all segments | £30,000 less 2 years’ allowance of £10,000 | £20,000 excess event gain |
| Full surrender of 29 segments for £30,450 | £30,450 less premiums of £29,000 | £1,450 |
The full surrender gain reflects real growth, while the part surrender gain is a mechanical result. The remaining 71 segments keep their own 5% allowances based on their own premiums. Check with the insurer how a withdrawal will be processed before asking for it, because the tax result follows the way the withdrawal is actually made.
What can be done if a wholly disproportionate gain has already arisen?
Sections 507A and 512A allow the person liable to apply to HMRC to have a part surrender or part assignment gain recalculated on a just and reasonable basis if it is wholly disproportionate. IPTM3596 sets out the key conditions:
- the application must reach HMRC within four years of the end of the tax year in which the gain arose; later applications are accepted only in exceptional circumstances;
- all persons liable, such as joint owners, must apply together, with the certificate, withdrawal request, policy history and a valuation immediately before the withdrawal;
- the threshold is high, and HMRC weighs the gain against the economic gain, the proportion of premium taken and the size of the resulting tax charge;
- no recalculation is made where the gain arises from arrangements with a main purpose of obtaining a tax advantage;
- there is no statutory right of appeal against the decision.
In Example A above, HMRC replaced the £191,000 gain with £1,500. In Example B it refused, because the tax charge was not significant. HMRC does not tell the insurer about a recalculation, so certificates on the final surrender will be wrong and the policyholder must keep records and report the correct gain, if necessary by amending a tax return.
What mistakes should bond holders avoid?
- Treating 5% withdrawals as tax free income rather than deferred gains.
- Calculating 5% of the current value instead of 5% of premiums paid.
- Working in tax years instead of insurance years.
- Taking a large lump sum early in the bond’s life as a part surrender without checking whether whole segments could be surrendered.
- Continuing 5% withdrawals after 20 years, when the allowance on that premium has run out.
- Forgetting that the settlor of a trust holding the bond is normally the person taxed on an excess event.
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Related Accountapedia entries
- Loan trusts and discounted gift trusts
- Income tax and CGT during estate administration
- What income is tax free in the UK
- Reporting gains with the real time CGT service
- Lifetime ISA: bonus and withdrawal charge
- Onshore or offshore investment bonds: tax differences
Sources
- legislation.gov.uk: Act 2005 c. 5, section 507
- GOV.UK: Manual page IPTM3560
- GOV.UK: Manual page IPTM1510
- GOV.UK: Manual page IPTM7615
- GOV.UK: Manual page IPTM3510
- GOV.UK: Manual page IPTM7620
- GOV.UK: Hs320 gains on uk life insurance policies 2026
- GOV.UK: Manual page IPTM3545
- GOV.UK: Manual page IPTM3597
- GOV.UK: Manual page IPTM3830
Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.