Rachael Griffin, head of technical marketing at Skandia, explores the many reasons why investment bonds remain powerful tax planning tools.
With the recent alignment of onshore and offshore bonds in relation to time apportionment relief, it is a timely opportunity to revisit the tax benefits of an investment bond.
It is possible to take yearly withdrawals of 5% of the initial premium (and any additional premiums from the year in which they are added) without an immediate UK tax charge.
Furthermore, the 5% is cumulative if not used: so, where no withdrawals are made in year one, 10% can be withdrawn in year two and so on. The allowance continues until all of the original investment has been withdrawn.
Revisiting the benefits of an investment bond
Investment bonds are non-income producing assets and, therefore, are not generally subject to capital gains taxation year-on-year. In the most simplistic form, taxation is based on any gains that are made.
In an investment bond, a client can ‘choose’ the time they make a withdrawal and, therefore, when a gain would be made.
Consider a client who is currently an additional rate taxpayer (45%) but envisages they will be a basic rate taxpayer (20%) in the future, possibly as a result of retirement – they are able to surrender the bond at the time that best suits their personal situation. This may result in them paying significantly less or no tax.
It is also possible to assign a bond by way of a gift to a new owner and any gain will be chargeable at the new owner’s current rate of tax.
An investment bond allows the client to switch between funds without any personal tax charge. For clients who actively manage their own portfolio, this can simplify the administration as there is no tax trigger on changing assets which might otherwise restrict active portfolio management.
As a general rule, if no gain is made, then there is no requirement to report the bond on an individual’s self-assessment return.
Life fund taxation
In some jurisdictions, such as the Isle of Man, which is favoured by many offshore bond providers, insurers do not currently pay tax on the life fund. Therefore, the responsibility to pay the tax falls on the client.
However, the funds which clients invest in through an onshore investment bond generally are subject to life fund taxation in the UK, which satisfies a client’s personal liability of basic rate tax.
Where a gain is made on a bond that pushes the client into either the higher (40%) or additional rate (45%) tax bracket, top-slicing is a way to reduce the gain. This works by effectively reducing the gain by the number of years the policyholder was UK tax resident, in comparison to the number of years the policyholder has held the bond.
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