Chargeable Event

EdInvestor

It's interesting to note that excluding endowments, investment bonds are the top cause of complaints to the financial ombudsman these days.

The actual taxation differences between a unit trust and a bond is not great.

It's 20%/nil and 22%/nil for basic rate taxpayers investing small sums.

Although, if she was a non taxpayer up until a few years back, she would have been able to claim tax back on the unit trusts but not the bond.

Exactly.

The information I have posted on investment taxes is not factually incorrect.All investors have an annual allowance (currently 8.8k) for realised capital gains (no tax is payable if no gain is realised).Dividend income arrives with a 10% tax credit equivalent to the amount payable in tax by basic rate taxpayers, thus no further payment is required.Non and lower rate tapayers cannot claim this back,but will still be paying only half the rate on income charged with the bond.

The situation is even worse if ISAs are not used for any of the money, as no tax is chargeable with ISAs under any circumstances.

What should happen with a lump sum is that in year 1, the 7k maxi ISA allowance should be used, and the rest invested directly in funds or shares.In year two 7k in gains should be realised (under the annual tax free allowance) and placed in the ISA.And so on until all money is in the ISA and totally tax free.

It is quite easy to obtain a 5% annual income ( which is a genuine income,not a withdrawal from capital as with the bond) by investing in funds such as equity income funds and property funds with a good yield payout.

The trouble with the capital withdrawal system in the bond is that if/when the market goes down, taking the income immediately starts depleting the capital, often without people realising it ( many people got a big shock in the past 5 years).That's the other unexpected nasty,along with the tax on gains.

Hereward

EdInvestor wrote:

It is quite easy to obtain a 5% annual income ( which is a genuine income,not a withdrawal from capital as with the bond) by investing in funds such as equity income funds and property funds with a good yield payout.

Um, I may have missed something here, but if I was drawing a 5% income from my investments, which isn't dervived from my capital, wouldn't I need to pay income tax on it if the income is greater than my personal tax allowance?

dunstonh

Um, I may have missed something here, but if I was drawing a 5% income from my investments, which isn't dervived from my capital, wouldn't I need to pay income tax on it if the income is greater than my personal tax allowance?

Yes you would. The income on the shares would have tax deducted already and the income would be included on means testing for pension credit and against age allowance as well.

There are also issues over high yielding shares as they tend to suffer poorer growth. LTSB is a good example of that. There are pros and cons to every sort of investment. With HYP, you tend to only read the pros and never the cons.

The trouble with the capital withdrawal system in the bond is that if/when the market goes down, taking the income immediately starts depleting the capital, often without people realising it ( many people got a big shock in the past 5 years).That's the other unexpected nasty,along with the tax on gains.

If/when the market goes down anyone owning shares would suffer a capital loss as well. The HYP would drop in value. Plus when the growth on the market returns, high yielding shares tend not to grow as much. LTSB being a good example. If the bond is invested in a sector allocated portfolio matching the risk profile of the individual then there is no problem. Its quite logical really. If the investment grows at 10% a year on average, then if you take 5% a year, you are drawing less than it makes. A medium risk portfolio would have seen around 15% a year for the last 3 years. So, if taking 5% you are getting 10% growth a year. If we now suffer say a 10% drop in the markets and then a year of zero growth you are still in surplus by 10% because you have drawn out less than it makes. (3x10=30. minus 10% drop =20. two years of 5% withdrawal with no growth =10% leaving you 10% surplus).

In any investment of any type, including savings accounts. If you draw more than it makes your value will go down. I cannot understand why Ed feels that this situation is unique to investment bond?

EdInvestor

dunstonh wrote:

The income on the shares would have tax deducted already

The dividend income comes with a tax credit for the same amount as the tax payable (10%.)Thus no tax is deducted.

There are also issues over high yielding shares

Who mentioned high yielding shares/HYPs? Equity income funds, property funds, corporate bond funds, PIBs, cash, gilts all pay an income - use your ISA for some asset types to avoid tax. You don't have to have a bond to have assets allocated by sector.Just buy different funds.

In any investment of any type, including savings accounts. If you draw more than it makes your value will go down. I cannot understand why Ed feels that this situation is unique to investment bond?

With a cash account, you receive interest, typically 5% a year in the better accounts.Many people just take the interest for spending, leaving the capital in the account. When old people are sold these bonds, they are led to believe that the 5% they are taking annually is "tax free income", ie equivalent to savings interest or dividends on shares/funds.

But it isn't.The money comes from their capital.If the earnings of the capital ( which are remember very often reduced by very high charges) are low, and if the capital value doesn't increase much (many people's investments are in negative territory this year) or falls, the withdrawal of 5% will not only reduce it further but also cause next years returns to be affected because there is less capital to invest.A downward spiral can easily result.How often is this risk made clear?

If people understand that the money is from their capital, and that this is one of the risks of investment bonds,fine. But we need to remember that many (most?) of the customers of these bonds are old people with little or no investment experience.For years they were sold the With profits version of these bonds as an alternative to a BS bond. Hence the surge of misselling complaints in recent years.

Chrismaths

Could I just be clear Ed, if the law was changed so that Basic rate tax was always deducted at source, and that you could not reclaim it, would that make the interest tax free?

That is what you are saying when you say divis are tax free, or that no tax is deducted.

Dividends have 30% tax deducted at source.

Tiggs_2

EdInvestor wrote:

When old people are sold these bonds, they are led to believe that the 5% they are taking annually is "tax free income", ie equivalent to savings interest or dividends on shares/funds.
.

That is miss selling/lies on the part of the salesman - has nothing to do with bonds.

Its like saying the BMW salesman said my car could fly.....but it cant so BMW's are rubbish.

dunstonh

That is what you are saying when you say divis are tax free, or that no tax is deducted.

On that principle, investment bonds would be tax free. This is the point that Ed argues as a negative of investment bonds but doesnt occur on dividends. An incorrect point as keeps being pointed out but ignored.

Its like saying the BMW salesman said my car could fly.....but it cant so BMW's are rubbish.

You mean they dont?

Dont you find it ironic that ed says "When old people are sold these bonds, they are led to believe that the 5% they are taking annually is "tax free income" that she is saying exactly the same thing about dividends?

So when advisers say it its a mis-sale but when amateur investors say it, it is correct?

ReportInvestor

Chrismaths wrote:

Dividends have 30% tax deducted at source.

Yet higher rate taxpayers have a further 22.5% to pay .

Please confirm this abomination.

Have you recently applied for a job with the Treasury?

Chrismaths

That's right. The 30% I refer to is of course corporation tax - Here's an example.

The pre-tax profit attributable to my share of a company is £1000. The company then has £300 deducted in corporation tax, leaving £700, which they pay out as a dividend. This dividend, magically, now has only a 10% tax credit attached to it, which settles the basic rate tax liability of 10% - however, as you will now doubt have spotted by now, the profit attributable to me has been taxed at 30%.

If I am a higher rate taxpayer, I have received a notional (including tax "credit") income of £777.78. So I have to pay a further £175 in tax - taking my net income to £525, or an effective tax rate of 47.5%.

It gets even worse when you consider the effect of selling a good with vat on it.

It really p's me off when Ed perpetuates myths such as "tax-free" dividends, another of Labour's great cons.

[political rant]The best solution to the idiotic inconsistencies in the tax system is a flat tax, payable on ALL income - no exceptions, at the same rate by companies/individuals/partnerships/trusts - so long as the money is taxed once and at the same rate. There are currently at least 7 rates of income and corportation tax - 0, 10, 19, 20, 22, 32.5, 40 - plus all the tax trap rates with tapered tax credits/benefits awards etc. It's just plain daft.[/political rant]

ReportInvestor

Chrismaths wrote:

That's right. The 30% I refer to is of course corporation tax

Does that affect all investors?

Nil rate taxpayers?
Basic rate taxpayers?
Top rate taxpayers?

Please clarify.