Investment bonds .vs. standalone OEICs

spotted_orchid

Hello,

I am researching investment bonds, such as the Aviva Portfolio: I thought understood how they work, in particular the 5% annual tax-free limit, but while looking into standalone OEICs I've got myself confused.

As I understand it, with standalone funds you get an income in the form of a dividend - arising from any dividends/returns from the underlying investments. However, all the documentation about the Portfolio bond implies that any income you take from the bond is obtained by cashing in units.

My question is: when you wrap the funds up in the Portfolio tax-wrapper, what happens to the dividends from the underlying investments? Can you chose to receive them, or are they automatically re-invested to give the growth of the bond?

Any guidance will be much appreciated,

Thanks

dunstonh

I am researching investment bonds, such as the Aviva Portfolio

Used to be well priced investment bond. However they have reduced the terms a bit and others come in better.

thought understood how they work, in particular the 5% annual tax-free limit

They do not have any tax free status. Tax is paid on the funds at source at 20% (minus taper relief). The 5% is an annual allowance that can be withdrawn that does not trigger a chargeable event (and a calculation for tax). It should never be referred to as tax free.

As I understand it, with standalone funds you get an income in the form of a dividend - arising from any dividends/returns from the underlying investments. However, all the documentation about the Portfolio bond implies that any income you take from the bond is obtained by cashing in units.

If you use a conventional insurance company investment bond, then virtually all the funds are accumulation units. All dividends and interest are paid into the fund and reflected in the unit price. Withdrawals are typically done by being capital withdrawals by encashing units (hence no income tax).

More modern platform based investment bonds can invest in unit trust/OEICs but allow either natural income or cancellation of units but the 5% rule still applies.

Unwrapped Unit Trust/OEICs can work the same way if you want them to and for some people, using low/no yield funds but making capital withdrawals can be a tax efficient way to provide an "income".

spotted_orchid

Thank you for your reply.

dunstonh wrote: »

They do not have any tax free status. Tax is paid on the funds at source at 20% (minus taper relief). The 5% is an annual allowance that can be withdrawn that does not trigger a chargeable event (and a calculation for tax). It should never be referred to as tax free.

My mistake - slip of the keyboard. As for "never be referred to as tax free" - try telling that to the IFA who introduced us to them in the first place. He emphasised several times that they were tax free. The word "deferred" never came up.

If you use a conventional insurance company investment bond, then virtually all the funds are accumulation units. All dividends and interest are paid into the fund and reflected in the unit price. Withdrawals are typically done by being capital withdrawals by encashing units (hence no income tax).

Thanks - that has made it very clear.

More modern platform based investment bonds can invest in unit trust/OEICs but allow either natural income or cancellation of units but the 5% rule still applies.

Could you clarify what you mean by "platform based" - I have only come across the bonds being sold by insurance companies.

Thanks.

dunstonh

Could you clarify what you mean by "platform based" - I have only come across the bonds being sold by insurance companies.

Most of the investment platforms offer an onshore or offshore investment bond now (although some only offer the onshore version). These allow greater investment choice as you dont need to use insured funds but can use the "real" unit trust/OEIC funds. They treat the bond wrapper in the same way as they treat ISA and pension wrappers.

spotted_orchid

dunstonh wrote: »

Most of the investment platforms offer an onshore or offshore investment bond now (although some only offer the onshore version). These allow greater investment choice as you dont need to use insured funds but can use the "real" unit trust/OEIC funds. They treat the bond wrapper in the same way as they treat ISA and pension wrappers.

My apolgies, but I am still not clear. My understanding was that an investment bond (such as the Aviva Portfolio and the Zurich Sterling) was constructed as a single premium life assurance policy inside of which you could choose a number of different funds. Are there different forms of investment bonds that offer the same tax deferred facility. Could you, perhaps, and without indicating preference, give me an example of these more modern types of bond.

Thanks

dunstonh

Are there different forms of investment bonds that offer the same tax deferred facility.

Yes. You have onshore and offshore versions which is the main product difference.

Then you have the provider differences. Old style insurance company based ones use life funds which are either internal funds (own brand, in-house managed) or external funds which are usually mirror funds of the unit trust/OEIC version. The ability and success as to how they track the main UT/OEIC fund varies with different providers. The other provider type is those offered by the platforms, such as Transact, Elevate, Ascentric, Skandia (not Skandia life but Skandia investment solutions) etc. These can use the unit trust funds themselves and dont use life funds (some can also allow shares, Investment Trusts, ETFs etc). Much more flexible on investment choice. Can be a bit more expensive (but in some cases not - depending on your investments) but the ability to use the real fund and not some mirror fund can often appeal.

gadgetmind

dunstonh wrote: »

Unwrapped Unit Trust/OEICs can work the same way if you want them to and for some people, using low/no yield funds but making capital withdrawals can be a tax efficient way to provide an "income".

Dividend yield is only a problem for higher rate tax payers, or those who want to avoid removal of (for example) age related personal allowance.

It's also work noting that accumulation funds are well worth avoiding holding unwrapped as you *do* need to allow for the reinvestment of income within the fund, both ongoing and for final capital gain purposes. I tend to only hold simple things such as equities unwrapped for this very reason - I just don't want the paperwork!

spotted_orchid

Thanks for the replies - things are clearer to me now.

dunstonh

Just hit the media today was a freedom of information act release from the FSA:

The FSA was initially prompted to launch its review due to long-term concerns about unsuitable investment bonds sales and the changes to the capital gains tax regime in 2008, which made collectives more attractive to higher rate tax payers.

The FSA found that in its sample of 333 investment bond sales files around 70% of customers were basic rate taxpayers and 72% did not make any withdrawals from the bond. The average tax detriment for customers investing £150,000 was £740 but a small proportion who invested over £150,000 may have been better off in bonds versus collectives, it found.

The cost of investing in bonds compared to collectives was lower over 10 years in 69% of cases, and in 82% cases over five years, the FSA said. ‘This is contrary to our assumption and overturns the presumption that investment bonds are more expensive than collectives for externally managed funds,’ it said.

‘We now consider there is no consistent and material level of tax disadvantage to basic taxpayers advised to invest in bonds…no standard assumptions can be made,’ the regulator said. ‘A simplified approach to accurately assess suitability on the basis of tax is not possible and the level of overall detriment for basic rate taxpayers is not material.’

source: http://www.citywire.co.uk/new-model-adviser/revealed-why-fsa-shelved-investment-bond-probe/a539546?ref=new-model-adviser-latest-news-list

It is a shame edinvestor is no longer with us and how this thread would develop with that information. It has been discussed many times over the years that bonds are often not as good for tax but can be offset with lower charges.

Rollinghome

spotted_orchid wrote: »

I am researching investment bonds, such as the Aviva Portfolio: I thought understood how they work, in particular the 5% annual tax-free limit, but while looking into standalone OEICs I've got myself confused.

There's an article about the disadvantages of investment bonds on Justin Modray's website here http://www.candidmoney.com/questions/question283.aspx and a few others there if you do a search.

The sales puff by advisers that the 5% withdrawal allowance is "tax-free" seems to be quite common: a friend I accompanied to see an adviser was recently told the same thing. Probably means you'd be better with a more honest adviser - also dealt with in articles on that site.

You would normally be able to ask Justin questions directly but he's just had a baby daughter and is a little more busy than usual.

jamesd

dunstonh wrote: »

The cost of investing in bonds compared to collectives was lower over 10 years in 69% of cases, and in 82% cases over five years, the FSA said. ‘This is contrary to our assumption and overturns the presumption that investment bonds are more expensive than collectives for externally managed funds,’ it said.

That's pretty hard to believe if an S&S ISA was th alternative vehicle being considered. Seems more likely if investing outside a tax wrapper was the not particularly efficient alternative investment method.