By ADRIAN LOWCOCK 01/04/2010
Investment bonds are products typically sold by life assurance companies, which allow you to invest in a variety of funds (either Investment Trusts or Unit Trusts), managed by professional investment managers. They are usually designed for long term capital growth, but can also be used to generate income.
Investment bonds can invest in a wider range of assets than Savings Bonds, such as UK and overseas equities, commercial property, fixed interest securities as well as cash-like investments. Investors are able to decide how much of their money goes into which funds and are able change the mixture of their investments several times a year.
In the 1990s, a particular type of investment bond became more popular; With-Profit Bonds (WPBs). Their aim was to smooth out the gains and losses of the investment over the lifetime of the bond. The life insurance companies had control of the investment decisions and determined what the bonuses were. The Tech bubble collapse in 2000 saw a lot of investors in these products lose money and any early encashments were met with tough exit penalties called Market Value Adjusters (MVAs). These were introduced to protect investors who remained in the bond from being adversely affected. The losses incurred and the introduction of MVAs resulted in WPBs becoming less popular.
For tax purposes, investments bonds are treated as life assurance policies and therefore are subject to tax on the income and gain. It is the life company that pays the income tax, which may be lower than basic rate of Income Tax an individual would be liable to pay. Investors are not subject to capital gains tax or basic rate tax on gains or income. Higher rate tax payers may be liable for any additional income tax above the basic rate (currently 20%), but only when they cash in the investment or make partial withdrawals of over 5%.
There are special rules on insurance bonds where investors can take (or top slice) 5% of the value of the fund from the capital and take it without paying tax. This top slicing is a deferral of income tax and the investor will be liable for tax on the whole, but only at the time of encashment.
Investment bonds may be recommended in a number of situations:
If you are a higher rate tax payer looking for extra income, an investment bond may be suitable because the 5% annual withdrawal facility would mean there is no immediate tax liability.
The 5% withdrawal facility would also be useful if you are retired and want a supplementary income, but are in danger of falling into the age allowance ‘trap’. This is where the extra personal tax allowance you receive when you are aged 65-74 (£9,490 for 2009/10) is reduced if your annual income exceeds a certain level (£22,900 for 2009/10).
If you are an active investor with a large investment portfolio and you have already mopped up your annual capital gains tax allowance (£10,100 in 2009/10), you can use an investment bond to manage your investments and you will not be liable for capital gains tax when you make switches between investments.
In general, investors should use their personal ISA allowance first (£7,200 for those under 50 and £10,200 for those who are 50 or older by 5th April 2010) before considering investment bonds.
If there is anything you wish to discuss please call one of our investment professionals on 020 7189 9999.