Insurance Bonds

Apreciar

I have asked this question before but unfortunately as often happens the thread went of at tangent and the specifics were not answered.

The question is;
1. What exactly are Insurance Bonds
2. What are the advantages and disadvantages
3. Who are the specifically for
4. What other options do a similar job

Sorry I should have said questions.

Tiggs_2

buckle up!

Chrismaths

1. An insurance bond is a wrapper into which you place investments.
Talking about onshore bonds:
2. advantages: All tax is accounted for in the investment. If you are a basic rate taxpayer, you can cash it all in with no additonal tax to pay, and you get what is called top-slicing relief (so a £10,000 gain held for 10 years adds £1,000 to your notional income).
You can sometimes get access to investments that you can't get elsewhere (like certain in house property funds, leveraged loans etc)
If you are a higher rate taxpayer, you pay an effective tax rate of 36% instead of 40%.
disadvantages: As they usually have available a large commission to an adviser who sells them (around 6%, compared to a unit trust that will usually pay 3%), they are often sold by unscrupulous 'advisers' (read salesman) when they are in fact not suitable, and are very expensive.
investments in the fund pay 20% tax on unrealised gains, plus 20% on interest and 10% on dividends. So if you held an investment directly, you would get a CGT exemption, but you don't in the insurance bond.
3. They might be suitable for anyone who wants to invest - it all depends on tax circumstances. There are many different types that are suitable for people who have different objectives. It comes down to the investments in the bond.
They are particularly useful for trusts, as trust pay (effectively) higher rate tax, plus extra tax on distributions for some kinds of trust. As they do not produce a taxable income, they simplify administration and tax efficiency.
4. As mentioned before, an insurance bond simply changes the tax treatment of investments, it is a wrapper. Alternative wrappers include pensions of all kinds, ISAs, PEPs, OEICs, unit trusts, offshore insurance bonds, and others.

What is most important is to work out what you want your money to do for you, and then to work how to pay as little tax on those investments as possible.

[Runs and hides from ensuing war...]

EdInvestor

The basic things you need to know about them are

1.) They pay very high commission to the advisor and are thus often sold to people for whom they are not suitable

2.) They are not suitable for basic rate taxpayers

3.) Their cost probably cancels out the advantages for many higher rate taxpayers who are not actually what you might call 'rich'.

4.) The best alternative is to go to a discount broker and buy quality funds direct, with initial charges rebated.You pay no tax on the dividend income and no tax on capital gains unless you sell the funds and make more profit from doing so than your annual 9k CGT allowance ( double for couples).

investments in the fund pay 20% tax on unrealised gains, plus 20% on interest and 10% on dividends. So if you held an investment directly, you would get a CGT exemption, but you don't in the insurance bond.

This is perhaps the only insurance type investment I've come across where you pay MORE tax if you use the wrapper than if you don't.

Extraordinary.

AVOID.

RubyBish

Ive used up my isa allowance for this year any have been looking at alternative investments. I have been weighing up buying funds direct, investment bonds and looking for alternatives.

EdInvestor wrote:

4.) The best alternative is to go to a discount broker and buy quality funds direct, with initial charges rebated.You pay no tax on the dividend income and no tax on capital gains unless you sell the funds and make more profit from doing so than your annual 9k CGT allowance ( double for couples).

I would have thought that dividend income received on a fund outside of an ISA would be declarable income even if it is accumulated or reinvested and therefore taxable and also not revelevant to the CGT threshold. Is my understanding incorrect?

EdInvestor

I would have thought that dividend income received on a fund outside of an ISA would be declarable income even if it is accumulated or reinvested and therefore taxable

Dividend income on shares or equity fund income comes with a tax credit attached with meets the tax requirement for basic rate taxpayers.There is nothing further to pay. Higher rate taxpayers pay 25%. Thus for basic rate taxpayers there's not a lot of point in using your ISA for equity investments, though obviously over time a fund can mount up such that CGT might become a problem.But it would take a while....You will pay tax in a bond that you don't actually owe. :eek:

CGT is payable on realised gains in excess of 9k( 18k for couples). No tax is payable if the shares/funds that are not sold.

dunstonh

1.) They pay very high commission to the advisor and are thus often sold to people for whom they are not suitable

Only if the adviser takes the full commission. Otherwise they pay no more or less than any other investment.

2.) They are not suitable for basic rate taxpayers

Incorrect. There are a number of occassions that they can be beneficial to basic rate taxpayers.

3.) Their cost probably cancels out the advantages for many higher rate taxpayers who are not actually what you might call 'rich'.

Incorrect. You can get near 1% p.a. reduction in yields with investment bonds making them cheaper than most unit trusts. Take into account the tax savings and they could be very beneficial.

dunstonh

I have just processed a £100k investment bond and thought it would be good to put some real figures on this rather than "opinions".

The person is currently a higher rate tax payer but will be a basic rate taxpayer in the future. A good reason to do a bond instead of UT/OEIC but of course Ed is correct on charges in that they "can" be more than unit trusts.

However, on like for like commissions terms to ensure no bias (on NMA basis 1% plus 0.5% trail) the investment bond at 6% p.a. growth showed a 10 year figure of £167,000 compared with £150,880 for unit trust/oeics on same growth rate. The RIY for that bond over 10 years was 0.7% (and included funds like ML American, Inv Perp Asian, Fid Japan, Gart Emerg Mkts, NU Property etc).

So, as I have said a number of times before, to assume that an investment bond is going to be more expensive than unit trusts/oeics is wrong. If this person had ignored Inv Bonds, then they would have had an increased tax liability for some years and paid over £16,000 in charges more in that 10 year period.

Like any product, some sources will be cheaper than others and some providers will be more expensive than others. I could have arranged a bond that was more expensive than the Unit Trust/OEIC but there were an awful lot that were cheaper. You shouldnt measure a product by its most expensive version or way of buying it.

Chrismaths

However, on like for like commissions terms to ensure no bias (on NMA basis 1% plus 0.5% trail) the investment bond at 6% p.a. growth showed a 10 year figure of £167,000 compared with £150,880 for unit trust/oeics on same growth rate.

Just for a bit of balance, as pointed out before, it's not really fair to illustrate an OEIC/UT and investment bond at the same growth rate, due to the annual charge to CGT in a bond. This demonstrated by the fact that you illustrate an investment bond at 4/6/8, and an offshore bond (where there is no tax in the wrapper at 5/7/9.

With a bit of sensible tax planning, avoiding CGT shouldn't be too difficult on £100k, especially when using the ongoing ISA contribution (although if he is already doing that then that doesn't help!), or a wife/hubby - but he would be liable to extra tax on dividend and bond income. So I'm afraid I don't agree that you are comparing apples and apples. Offshore bond I'd agree with!

You are of course right that it is not necessarily charges that play havoc with returns, but tax treatment can do as well.

dunstonh

If you assume 1% is the impact in the difference in taxation, which is a fair average after comparing the same periods in the UT and Life funds, then 1% compounded over 10 years is £10,462. So, the bond still beats the UT as the charges were over £16k lower.

With a bit of sensible tax planning, avoiding CGT shouldn't be too difficult on £100k, especially when using the ongoing ISA contribution (although if he is already doing that then that doesn't help!), or a wife/hubby - but he would be liable to extra tax on dividend and bond income. So I'm afraid I don't agree that you are comparing apples and apples. Offshore bond I'd agree with!

You cannot get a 100% match but the point of the like for like was on commission terms and to show that the charges side can be quite a bit lower. Tax then adds a second layer of things to think about and for some it will be better and for some it will be worse. Offshore bonds tend to add a bit more in charges which can also negate the tax gains.

EdInvestor

The points here are

1.Basic rate taxpayers are not liable for tax on the income from investments in such a bond and can normally use the large CGT allowance easily to avoid tax on the capital gains. Whereas tax is automatically levied on investments within the bond, regardless of what type of taxpayer you are.

Thus, basic rate taxpayers should avoid.

2. You are quoiting NMA charges.Most advisors are not NMA and are taking considerably more.Thus your figures are not typical.

Again, basic rate taxpayers can usually do much better if they put their money in the same funds, where they won't pay tax, and use a discount broker which rebates charges, instead of using an investment bond.