We had a number of calls from last week’s column asking about (onshore) investment bonds and their taxation. Many believe they are very tax efficient, but sadly that is not true, except in very specific circumstances – the obvious one being Inheritance Tax Planning.
This is almost a rewrite of a column from 20 years ago and little has changed.
Back in the day when advisers received over 7% commission for investment bonds, it was easy to see their attraction – for the adviser. Indeed, some advisers returned every five years to ‘rebase’ the bond. It was really called churning and was a way to gain another run of commission.
A bond is often sold as a 5% per year tax free income, but it isn’t tax free. Its 5% per year over twenty years, which of course, is simply the return of your capital.
Bonds can also be very restricted to the choice of funds you can invest into. Choices, choices.
Investment bond or collectives. What are the choices?
Most of us should immediately use up our ISA allowance of £20,000 per person. Those looking to spread any further capital have further options to consider, but in many instances I see, a bond can be defaulted to, when clearly a range of Unit Trusts/OEICs, commonly known as collectives, are better for most.
Interest and rental income in a bond are subject to corporation tax at 20%, and on final encashment, that bond is assessed against income tax for the holder with a tax credit of 20% to reflect the tax already paid in the fund.
If you invest your money into a collective, there are two types of tax to consider. Collectives are only subject to tax within the fund on income received, so interest and rental income are subject to corporation tax at 20% with no further tax to pay on dividends.
Capital Gains allowance
The real gain in investments however is in Capital Gains. Collectives’ gains are subject to Capital Gains Tax, but they have a generous Capital Gains allowance many miss out on.
Each year we each have a Capital Gains allowance of £12,300. Therefore, if you had a fund which had grown from £50,000 to £62,300, you could dispose of that by encashing and later reinvesting, and your gain has been achieved tax free. £62,300 is your new starting point to calculate any further gains. And so, working with your Independent Financial Adviser and accountant, you can dispose of gains throughout the life of an investment.
Moreover, in each of those years, the gain could have been reinvested back into ISAs thereby sheltering that gain forever.
No Capital Gains are payable on death in a collective, so any rolled up gains on the investments will be effectively wiped out.
In any tax year if you wished to make a gift to your children, that gain could be assessed against your Capital Gains allowance which will otherwise have been lost.
If you had made a loss elsewhere, you could encash a collective and use up the gain by offsetting it against that loss.
Where one partner may not have as large an investment portfolio as another, there is no tax to be paid on the transfer from one partner to another, thereby sheltering those gains again.
The first £2,000 of dividend income from a collective is tax free.
Seek advice before acting
Nothing is ever just as simple as a column of this size can cover, so careful consideration with your Independent Financial Adviser is essential.
Aside from the taxation, investment bonds often have less access to the best funds to invest into, whereas a choice of collectives means you can access the very best fund for each, individual sector.
As you spread your investments across different areas to balance out risk, you want the very best manager. It is rare that an investment company is brilliant in fixed interest investing and say, UK equities or emerging markets, so the added flexibility of spreading across all sectors is vital, particularly as you rebalance year on year to readjust risk as each sector performs differently.
For a complimentary assessment of your investments, you can call 01872 222422, email [email protected] or visit wwfp.net
For more content like this visit our savings and investments channel.
About the Author / Peter McGahan
Peter McGahan is Chief Executive Officer of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.
