Your Guide to Investment Bonds

Investment bonds are a popular financial product offered by insurance companies, designed for individuals and Trusts looking to make a lump sum investment. Bonds provide access to a diverse range of investment funds and offer flexibility in terms of when they can be surrendered, though it’s important to note that surrender penalties may apply in certain situations.

What Are Investment Bonds?

Technically classified as whole-of-life insurance policies, investment bonds actually come with minimal life assurance. A policy typically has one or more ‘lives assured’, meaning that if the bond is held until the death of the last life assured, it will come to an end (‘mature’), and a lump sum will be paid out.

Alternatively, bonds can be set up on a ‘capital redemption’ basis. In this case, no lives are assured, but there is a fixed maximum term to maturity. This approach avoids the risk of the bond ending abruptly.

Structure and Flexibility

One of the unique features of investment bonds is that they can consist of multiple identical segments, with each segment functioning as a separate mini-policy. This segmentation allows investors to manage their investments more strategically, in particular, potentially reducing tax liabilities on investment gains.

Tax Benefits and Implications

Investment bonds offer significant tax advantages, particularly concerning withdrawals and fund management. Tax rules allow for annual or more regular withdrawals of up to 5% of the original investment amount without triggering an immediate tax liability. This 5% allowance is cumulative, meaning if no withdrawals are made in a given year, the unused allowance carries over to the following year. For example, if no withdrawals are made in the first year, up to 10% could be withdrawn in the second year without incurring tax.

Another key benefit is that fund switches within an investment bond do not trigger capital gains tax giving investors the freedom to adjust their portfolio without immediate tax consequences. However, profits realised upon encashment of the bond are assessed for income tax rather than capital gains tax. The tax on any profits made is deferred until the bond matures or if withdrawals exceed the cumulative 5% allowance.

Onshore vs. Offshore Bonds

The tax treatment of investment bonds depends on several factors, including whether the bond is ‘onshore’ or ‘offshore’, whether it is held in trust or by an individual, and, if held by an individual, their marginal tax rate. For onshore bonds, a 20% tax credit is given, which reduces the amount of tax due on profits. The rate applied to the average yearly gain determines the tax owed on the total gain.

Importantly, as long as you stay within the 5% annual withdrawal limit, no annual tax return is necessary for investment bonds, simplifying the administrative burden for investors.

Bonds Held in Trust

If you are a Trustee of a Trust, investment bonds may be particularly useful. They can be assigned to an adult beneficiary without triggering a tax charge. If the bond is then surrendered by the beneficiary, either in whole or in part, any tax due is assessed against the recipient as if they had held the bond since its inception. This feature can be particularly advantageous for estate planning and wealth transfer purposes.

Advantages of Investment Bonds

• Hassle-Free Income: Investment bonds are well-suited for those seeking regular, hassle-free income.
• Flexibility: The investments can easily be moved between different assets (shares, fixed interest etc) without incurring tax.
• Simplified Tax Reporting: There’s no need to file an annual tax return, making them a convenient option for trustees.

Disadvantages of Investment Bonds

• Income Tax Assessment: Profits from investment bonds are subject to income tax rather than capital gains tax, potentially leading to higher tax liabilities in some circumstances.
• Complex Tax Treatment: The tax treatment of investment bonds can be complicated, especially if you take high levels of withdrawals. Conclusion

Investment bonds can be a valuable tool for investors seeking a flexible, tax-efficient way to manage their wealth. However, it’s essential to understand the associated tax implications and ensure that they align with your financial goals and tax situation. With their unique benefits and potential drawbacks, investment bonds are best used as part of a broader, well-considered investment strategy.

 

Important Information

The above information is for educational purposes and is not a personal recommendation or investment advice. Content is accurate at the time of writing and tax limits and rates may change. If you are unsure about the suitability of a particular investment you should speak to an authorised financial adviser. The value of investments can go down as well as up and returns are not guaranteed. Wise Investment is authorised and regulated by the Financial Conduct Authority (FCA 230553). Registered Office: The Great Barn, Chalford Park Barns, Oxford Road, Chipping Norton, Oxfordshire, OX7 5QR. Registered in England 4970458