Like an ISA or pension, an investment bond is a highly flexible ‘wrapper’ through which a suitable investment strategy, aligned to an individual’s risk profile, can be built. As always, an investor’s circumstances and tax position will dictate the type of account (or wrapper) used.
Modern investment platforms offer a suite of accounts, including investment bonds, so these can sit comfortably alongside an ISA, pension or general investment account. The benefit? Investors can employ a unified, holistic investment and tax planning strategy.
There are many features and benefits of investment bonds. We have covered some which are typically most useful for tax planning. Only when all features and benefits are fully understood should an investment be considered.
The 5% rule
Each year, you can withdraw up to 5% of your original investment without triggering a tax liability. This 5% ‘allowance’ can be carried forward, so in year 5 you could take 25% of your original investment without giving rise to an immediate tax liability (provided you had not already made any withdrawals in that period).
These withdrawals are tax deferred, not tax-free. Any withdrawals in excess of 5% are a ‘chargeable event’ and assessable against income tax. If the bond is surrendered, any previous withdrawals are considered as part of the income tax calculations.
Non-income producing assets
Investment bonds are straight-forward when it comes to tax-reporting. Annual returns to HMRC are typically not required until a ‘chargeable event’ occurs.
Put simply, this is a calculation which works by dividing the growth on your bond by the number of years it has been held. It can be used when any gain from the bond pushes you into higher rates of income tax and ultimately could reduce the amount of tax you are required to pay.
Onshore versus offshore
UK investors, investing personally, have the luxury of investing in bonds domiciled inside the UK or outside. Structured in much the same way, it is their tax treatment which sets them apart.
|Taxation within the bond||Onshore||Offshore|
|Corporation tax is levied against the underlying investment and automatically deducted.
The investor is therefore deemed to have paid the equivalent of basic rate income tax (20%) even though the actual rate of tax deducted can be lower.
|Typically, no tax is deducted from the underlying investment, but there can be some tax taken from interest and dividends (called a Withholding Tax).|
|Tax on surrender or part-surrender||Basic rate income tax is deemed to have been paid. Once the profit from the bond is added to the investor’s income, no further tax is due if they remain within basic rates.
If the investor is already, or bond proceeds push them into higher or additional rates, they will have to pay a further 20% or 25% on the profit.
Non-tax payers cannot reclaim the 20% tax deemed to have been deducted at source.
|Tax on the profit from the bond is paid at the client’s marginal rate of income tax.
Investors can use any available personal savings allowance (PSA), so basic rate taxpayers can receive savings of up to £1,000 and higher rate taxpayers up to £500 in a tax year before paying any income tax.
Applies as outlined above.
|The gain is always calculated by the number of full years since the initial investment - not any previous chargeable event or withdrawal in excess of the 5%.|
|Investor Protection||Covered by the Financial Services Compensation Scheme (FSCS) up to 90% of the value of the claim, with no upper limit.||The protection available will depend on what jurisdiction the bond is domiciled in.|
Important note– investment bonds can be more complicated than anticipated and, without proper consideration, it is possible to incur an unexpected tax bill. It is therefore usually advisable to seek professional advice.
To discuss your tax and investment planning, request a call back.
This article is distributed for information purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Ermin Fosse and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Ermin Fosse’s services.
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