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A future for the Investment Bond?

The tax changes effective from 6 April 2016 impact the attractiveness of different investment types - where does this leave the investment bond?

The budget 2016 brought good news for investors with the announcements relating to Capital Gains Tax (CGT). Whilst the CGT annual exemption will remain at its current level of £11,100 for individuals, the tax rates are reducing from 18% to 10% for basic and 28% to 20% for higher/additional rate tax payers respectively with effect from 6 April 2016. This announcement has raised question marks over investment bonds and raises the question of whether they are an investment vehicle of the past or whether they still have a future?

Historically investment bonds have been a popular choice of investment wrapper for investors with money to invest for the medium to longer term. They are available onshore and offshore – from a tax perspective the difference being that offshore investments do not suffer tax on gains and income within the bond wrapper (with the exception of some withholding taxes) and therefore benefit from a gross roll-up whereas onshore investment bonds suffer corporation tax on the underlying funds but this is deemed to cover the liability to basic rate tax for the bond holder. 

With the introduction of new 10% and 20% rates of capital gains tax why would you want to invest in a bond?  A rate of 20% for higher and additional rate tax payers on an unlimited level of gains in excess of the CGT exemption cannot be ignored but is there still merit in considering an investment bond? More than ever holistic financial planning is critical to ensure your clients manage their investments in the most tax efficient way minimising their tax liability whilst maximising their income.

Diversification is a key consideration for any portfolio to minimise risk but the benefits of utilising different wrappers for tax efficiency is also important, perhaps more so now than before.

The use of different wrappers ensures facilitation of all available allowances for income tax purposes ensuring a tax efficient income where required but inheritance tax planning shouldn’t be overlooked.  It is also important and perhaps not given as much consideration as it should.  Careful planning enables assets to be efficiently passed to the next generation whilst minimising any inheritance tax liability.   

Some of the key benefits of investment bond are listed below. These show that alongside the use of the reduced CGT rates, dividend allowance and personal savings allowance the bond can still be part of an overall strategy:

Non-income producing asset

A reason why a bond is a popular choice for estate planning is that it is a non-income producing asset. This is crucial for trustees wanting to avoid the time and ultimately costs associated in annual trustee returns. When compared with collectives trustees must report interest and dividend income received on an annual basis where similar if not greater ‘income’ could be achieved by utilising the 5% tax deferred allowance.

Equities can be selected as part of the underlying investment within a bond without being taken into account as part of the dividend allowance.  All income is rolled-up into the bond.  Whilst as a general rule it would be considered unnecessary to hold equities within a bond where any dividends would otherwise fall within the dividend allowance, it is important to remember that dividends received within a bond are not subject to any further UK life fund tax but gains from an onshore bond benefit from a basic rate tax credit.

For example, a £100 dividend does not suffer tax within the bond and upon encashment benefits from the 20% tax credit.  This is good news for trustees as trusts do not have a dividend allowance.  Under chargeable event rules trustees have a further 25% tax liability on gains.  The net dividend position is therefore £75 whereas the same dividend received where the fund is directly held will be subject to tax at 38.1% leaving a net dividend of only £61.90.

5% tax deferred withdrawal allowance

Withdrawals can be made from an investment up to 5% of the initial investment for 20 years without incurring a chargeable gain and therefore potential tax liability.  Withdrawing money in this way, whilst also utilising the new £5,000 dividend allowance and the £1,000 personal savings allowance could see a higher level of tax free income received when compared to investing solely in collective investments.

Ability to use 0% starting rate band for savings income

Non-taxpayers can utilise the 0% starting rate of tax for the first £5,000 of savings income in addition to the £1,000 personal savings allowance from 2016/17. Gains from offshore bonds are considered offshore savings income and can therefore benefit from these 0% rates. An investor may exceed their 5% allowance (mentioned above) by up to £6,000 (i.e. the 5% plus another £6,000) without having to pay any income tax. It is unlikely that most collectives will yield enough income on the same size investment to provide this level of income and fully utilise these allowances.

Time Apportionment relief for temporary non-residency 

Investors in both onshore and offshore bonds can benefit from a reduced tax liability where they have been non UK resident for a period during the ownership of the bond. The result of the relief is that only a proportion of the gain is chargeable based on the period of time resident in the UK as a fraction of the total ownership. There is no such reduction for gains subject to CGT which are fully chargeable if realised whilst UK resident.

Inheritance Tax and Estate Planning

Investment bonds are a useful investment tool for estate and inheritance tax planning with many trust schemes being available such as Discounted Gift Trusts, Loan Trusts and Old Mutual Wealth’s new Lifestyle Trust. Most insurers will offer trust planning with a bond at the centre of it. The schemes offer IHT savings as well as opportunities to help manage income tax when the time comes to pass wealth down generations by assignment of bond policies.

Employing a professional trustee company can provide comfort that wishes will be carried out following death.  It also ensures the trust will be properly managed and reporting obligations met.  Old Mutual International (Isle of Man) Ltd has a professional trustee company established to take on this role and provide the appropriate reassurance.

Financial Protection

It’s not just about tax. In recent years investors have become more concerned about the security of their investments with the turbulence experienced with the banking industry.  The Financial Services Compensation Scheme provides protection for investors in the UK and the level of protection offered to individuals with a life assurance product (which covers bonds) is significantly greater than to those holding investments.

  • Life assurance offers 100%* protection with no limit compared to
  • % of the first £50,000 per firm for investments

* A similar scheme is offered in the Isle of Man (covering offshore bonds) which offers 90% protection with no limit.

For financial advisers only. Not to be relied on by consumers.

The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth or Old Mutual International's interpretation of the relevant law and is correct at the date shown at the top of this article. While we believe this interpretation to be correct, we cannot guarantee it. We cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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