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Investment Bonds Explained

Investment Bonds Explained

As you develop your financial portfolio, there are many types of investments available to you. In this article we will explore the investment bond and what benefits it can add to your medium to long term investment strategy.

What is an Investment Bond?

First of all it is key to note that like all investments, bonds are no exception and they are liable to fluctuate with a potential loss of original investment funds but they do provide on balance a strong potential for medium to long term growth on your cash.

Along with a sound fund management expertise, investment bonds form the basis of many investment portfolios across the country and are usually classed as a single premium ‘life insurance’ policy that can be paid out upon death. In reality however they are an investment product and if you are looking for a dedicated life insurance product, we would suggest that you research a life insurance product to match your requirements and budget.

The investment bond is usually arranged via a life insurance company or directly from an Independent Financial Adviser who will invest your premium on your behalf in order maximise its potential capital growth – this should continue to grow until you decide to cash out your policy. You are also eligible to withdraw up to 5% of your investment bond per year without incurring an immediate tax liability.

Please note that some investment binds may require a minimum investment term before being allowed to cash out. Equally some providers may apply a pre-minimum term charge before releasing funds and typically will range between £5000-£10,000.

Differing Types of Investment Bonds – On & Offshore Bonds Explained

Investment bonds generally fall into two categories – onshore and offshore.

The main difference between the two is their tax treatment. In broad terms, onshore investment bonds are subject to UK corporation tax, which is offset by your provider. While offshore bonds are issued from outside the UK, they may also offer a wider choice of funds and options. There are other types of common bonds as well, which include fixed-rate bonds, corporate bonds and government bonds. Each have their own benefits and risks and the tax situation of each can vary. Before making ay decision we always advise that you take expert advice.

Onshore Investment Bonds

UK Investment Bonds are non-income producing investments and so have a different tax treatment from other UK based investments and as such can provide valuable tax planning opportunities for individuals as part of a balanced portfolio.

Tax and Liabilities: The funds that underlie the bond are all subject to UK life fund taxation meaning that you are treated as having paid Income Tax at the basic rate on the amount of your gain. This is a notional tax and as such is not repayable in any circumstances. You also will have no liability to Capital Gains Tax or basic rate Income Tax on bond gains.

There are certain events however, also known as chargeable events, that can occur during the lifetime of your onshore investment bond may trigger a potential Income Tax liability and will vary according to each provider:

  • Transfers of legal ownership of part or all of the bond (though not gifts)
  • You choose to cash in all your bond or individual policies within it
  • Cashing in upon Death
  • On the maturity of the bond (only applies to Capital Redemption bonds)

As you’re treated by the HMRC as having paid basic rate tax on the amount of the gain, the maximum rate you would be liable for is the difference between the basic rate and higher or additional rate tax. The gains made may also affect your eligibility for certain tax credits and you could lose some or all of your entitlement to personal allowances.

Future Planning: If you are currently a higher or additional rate taxpayer at the moment but know that say upon retirement you will become a basic rate taxpayer, then you may consider deferring any withdrawals from the bond (in excess of the accumulated 5% allowances) until that time.

Please Note: If you do this, you may not need to pay tax on any gains from your bond. Life assurance bonds held by UK corporate bonds also fall under different legislation. Special rules apply to trustee held bonds.

Offshore Investment Bonds

Offshore is a commonly used term that is used to describe any number of largely tax-free locations from where a company could offer customers growth on their funds.

This includes but is not limited to ‘true offshore’ locations such as the Channel Islands and the Isle of Man, and other locations such as Dublin or Gibraltar. Tax treatment can vary from one type of investment to another, and from one market location to another. As always we recommend expert advice to tailor your requirements to the right offshore jurisdiction.

Tax and Liabilities: Offshore investment bonds are similar to UK investment bonds in that they also incur chargeable events similar to that of onshore bonds. There is however one major difference.

With an onshore bond, the tax is payable on gains made (and investment income received) from the underlying investments of the life fund(s) invested in, whereas with an offshore bond no income or Capital Gains Tax is payable on the underlying investment.

The lack of tax on an offshore bond means that potentially it could grow faster than one that is based onshore, although as with any investment this isn’t guaranteed.

Please Note: You will be eligible to pay income tax on any gain at your highest marginal tax rate. This is because on an offshore bond you are not treated as having paid basic rate tax on any gain. The gains may also affect your eligibility for certain tax credits and you could lose some or all of your entitlement to personal allowances.

Top Slicing Relief for Onshore and Offshore Bond Gains

Top slicing relief, as it is known is most commonly available where you are liable to tax at a lower rate were it not for the inclusion of the chargeable event gain in your income for the year. It may reduce the tax payable on a bond gain, but it does not reduce the gain.

You may get a reduction on the tax payable on any chargeable event gain. This is a hugely complex area and please always consult an expert IFA or contact the HMRC.

Withdrawals from Your Bond

With all this said, an investment bond could therefore be a potentially tax-efficient way of holding a range of investment funds in one place.

You can withdraw up to 5% each year of the amount you have paid into your bond without paying any immediate tax on it. This allowance is cumulative so any unused part of this 5% limit can be carried forward to future years (although the total cannot be greater than 100% of the amount paid in). You will often see this referred to as the “5% tax-deferred allowance”.

However, if you decide to take more than the accumulated 5% tax-deferred allowance, you will create a gain equal to the amount taken over the allowance and will be liable for fees.

Choosing the Right Bond Funds

When you invest in a bond you will be allocated a certain number of units in the funds of your choice or those set out by the conditions of the bond.

You can choose to invest in a range of funds, a portfolio, or a mixture of both. You can also usually switch between funds within your bond. However, there may be a charge for this. Each fund will invest in a range of assets, such as fixed interest, shares and property, and the price of your units will normally rise and fall in line with the value of these assets.

Further Information

If you need more information on bonds, we advise you to speak to a tax specialist or contact a financial adviser. Information is also available on the gov.uk website.