Investment bonds, or to give them their correct title, single premium non-qualifying whole of life insurance policies, are unique investment products which are taxed under insurance company legislation. There are mixed opinions about investment bonds in the financial adviser community. So they are Marmite products. They are either loved or hated by advisers.
Investment bonds are uniquely subject to Income Tax only when they are partially or fully surrendered (encashed). Surrenders of up to 5% a year, cumulative, of the original investment, are tax deferred, not tax-free. This means that a tax deferred income may be taken for up to 20 years if the maximum income is taken.
Bonds become subject to Income Tax whenever there is a chargeable gain as evidenced by a chargeable event certificate which is issued by HMRC. Many investors confuse chargeable gains with capital gains. They are not one and the same. A chargeable gain from an insurance product such as an investment bond is subject to Income Tax. A capital gain on the other hand is subject to Capital Gains Tax.
There are onshore and offshore bonds. Onshore bonds are issued by UK insurance companies. Taxation is paid within the life office funds and the investor is therefore deemed to have paid basic rate taxation at source. The taxation of capital gains and income is levied on the insurance company rather than the investor.
Offshore bonds on the other hand have no taxation deducted at source on the insurance company’s income and capital gains so the investor does not benefit from a basic rate tax credit. On the other hand, such an investor benefits from “gross roll-up” which means that taxation may be deferred for many years, even decades. However, taxation will finally be paid on all investment bonds when they are surrendered, part surrendered or the last of the lives assured dies. Offshore bonds are issued by offshore related companies of UK insurance companies and usually in local tax havens such as the Channel Islands, Isle of Man and the Dublin Financial Services centre.
So what are the advantages of investment bonds?
- Inheritance Tax mitigation if gifted into trust or used within a packaged IHT product such as a loan trust or discounted gift trust
- Trust investment
- Long term care fees savings due to exclusion from local authority financial assessment apart from any withdrawals taken (but deliberate deprivation rules need to be taken into consideration)
- Tax deferment especially offshore bonds
- Income planning
- School fees and further education planning
- British expatriate investment due to 100% tax exemption for periods of non-residence known as time apportionment relief
These are the disadvantages of investment bonds.
- Tax inefficient as capital gains and income are subject to taxation unlike pensions and ISAs
- Charges are relatively high especially on offshore bonds
- Income Tax on surrender, part surrender or death cannot usually be avoided
- Frequent poor service and administration by insurance companies
So to summarise investment bonds do have their place and are especially useful for wealthy investors, non-resident British Expats and, indirectly, for care fees mitigation. However, they do suffer to an extent from certain tax inefficiency and complexity too. When it comes to investment bonds it is very much an issue of each case on its merits. Under certain circumstances, investment bonds can be invaluable. On other occasions, they are simply complex and some of their taxation advantages can be illusory when taking into account the inevitability of an Income Tax charge one day.
So if you are considering investing in investment bonds do weigh up the advantages and disadvantages based on your individual circumstances.* You know it makes sense.
*The value of investments and the income from them can go down as well as up and you may get back less than the amount invested. The Financial Conduct Authority does not regulate tax advice or trusts. The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist. This blog is based on my own observations and opinions.