In this article, our expert team of financial advisers at PIL Southampton focuses on investment bonds.

They explain what they are, the different types available, their tax implications and more.

What are investment bonds? 

An investment bond is a single premium, medium- to long-term growth wrapper.

They are not as popular as ISAs because the tax savings are not as generous. However, they can be attractive to higher rate taxpayers and those who have used up their ISA allowances. 

With an investment bond, your lump sum is pooled with other investors’ money and invested into various funds by the bond provider. These funds are managed by professional fund managers. 

Although investment bonds are an investment product, they are generally classed as a type of life insurance policy because a portion of them can be paid out after the policy holder’s death.

However, being an investment product, if your primary need is life insurance then more specific life insurance policies may better suit your needs. 

Why would you invest into bonds? 

In addition to those who have fully utilised their annual ISA allowance, Investment Bonds offer a means of diversification and, for higher rate taxpayers, the means of deferring tax until their tax status changes. 

Investment Bonds are often treated as exempt assets by Local Authorities. They can therefore be a useful way of protecting some of your assets from being considered in any future residential care fees assessment, although this should not be the primary consideration.

What types of investment bonds are there? 

Most investment bonds are either onshore or offshore with the key difference between the two being how they are treated for tax reasons. Each have their own pros and cons and specific tax rules.

Onshore investment bonds 

Onshore investment bonds, known as UK Investment Bonds, are subject to UK corporate tax, which is offset by your provider. 

As they don’t produce income, tax-wise they are treated differently to other UK-based investments. This can provide advantageous tax planning opportunities for investors.

The funds that underly the bond are subject to UK life fund taxation. This means that gains are treated as having paid income tax at the basic rate. This notional tax cannot be reclaimed but you will have no liability to capital gains tax or basic rate income tax on bond gains.

Income tax may be due if the gain on full or partial surrender pushes you into higher rate tax for the year but gains can be ‘top-sliced’ over the period a bond has been held.

Gains may also affect your eligibility for some tax credits and you might lose some or even all of your entitlement to personal allowances.

If you are currently a higher or additional rate taxpayer but expect to become a basic rate taxpayer in the future, for example when you retire, you might consider deferring any withdrawals that are above the 5% allowance until then.

Doing this might mean you won’t have to pay additional tax on any gains from your investment bond.

Offshore investment bonds 

Offshore Bonds are available from life companies outside of the UK. They offer investment growth that’s mostly free from tax. ‘True’ offshore jurisdictions include the Channel Islands, the Isle of Man and Dublin. Tax treatment will vary between types of investments and locations.

The main difference with an offshore investment bond, compared to an onshore investment bond, is that no income tax or capital gains tax is payable on the underlying life fund investments, which means investment growth will be higher. Note: There may, however, be an element of withholding tax (deducted from interest and dividends received by the fund/s) that can’t be recovered.

However, all gains made on full or partial surrender of an offshore bond will be paid at your highest marginal tax rate because, unlike with an onshore fund, the bond is not treated as having paid basic rate tax on any gain. 

Gains may also affect your eligibility for particular tax credits and you could lose some or all of your entitlement to personal allowances.

An offshore fund could potentially grow faster than an onshore fund due to the lack of tax, although this isn’t guaranteed. You also need to take other factors like fund management charges into account when you are comparing fund types.

Top slicing relief 

The tax treatment for investment bonds can mean that investment returns that build up over multiple years are taxed in a single year, when a chargeable event occurs.

Top slicing relief aims to smooth out this spike, by trying to put the taxpayer in the position they would have been in if they had been taxed annually throughout their investment period.

Even when a gain doesn’t move you into a higher tax rate, you may still get top slicing relief because of the effect of the personal savings allowance nil rate and the starting rate for savings.

HMRC has a process for calculating top slicing relief. It can be complex, so you may wish to speak to one of the financial advisers at PIL Southampton who specialise in this area.

Withdrawals from investment bonds 

Each year, you can withdraw up to 5% of your investment bond without paying any immediate tax on it.

This 5% allowance is cumulative, which means that you can carry forward any unused part of the 5% allowance into future years. This is capped at 100% of the amount you have invested and it’s often referred to as the ‘5% tax-deferred allowance’.

If you choose to withdraw more than your accumulated 5% tax-deferred allowance, that amount will be treated as a chargeable event gain. Your insurance company will inform you of these details so that you can notify HMRC, as this gain might be subject to income tax.

Choosing funds 

Your investment will give you an allocated number of fund units. You may be able to choose where to invest those fund units or the conditions of the bond may dictate that choice. Your fund units will be invested in a portfolio, a range of funds or a combination of the two. 

Each fund is likely to contain a diverse range of assets, like fixed interest, shares and property, to spread the risk of fluctuations caused by changes in the market.

You are likely to be able to move your investment between different funds during the investment period, though you may be charged for this.

Changes that can trigger tax 

There are particular events, known as chargeable events, that can lead to an income tax liability (not capital gains tax). These events include:

• Withdrawing more than the 5% annual tax-deferred allowance.
• Cashing in your whole bond or an individual policy within it.
• When your bond matures: this only applies to capital redemption bonds.
• Benefits in the event of the policy holder’s death.
• Transferring legal ownership of all or part of the bond when it’s not a gift.

Risks

The aim of an investment bond is to achieve capital growth but, as is the case with investment products, the value can go down as well as up and you might not get back as much as you paid in.

Past performance is not a guide to future performance.

Laws and tax rules may change at any time.

How PIL Southampton can help you 

Our expert team of investment advisers is highly knowledgeable about investment bonds. We keep up to date with the product range available across the marketplace and will find the most suitable options that should best suit your needs. 

How you can contact PIL Southampton

You can email us, fill out the contact form on our website or call us on 02380 668407. We look forward to hearing from you.