Withdrawing funds from a single premium investment bond

Legacy_user

I have read that it is possible to withdraw an income of up to 5% per year of an original investment for a period of up to 20 years without any personal tax liability and they would not have be declared on a tax return. However the article also said that any potential tax liablility is deferred not avoided.

Could someone explain what this actually means in lay mans terms.

Thanks

dunstonh

Are you talking about onshore bonds or offshore bonds?

The difference is similar but both defer the liability. However, onshore bonds get the tax credit on investments which satisfies basic rate liability and capital gains tax is paid within the funds (where CGT is payable - not all funds are). Offshore bonds pay no tax and that means you can benefit from gross roll up (gross interest/income on the gross interest/income).

For onshore bonds, when you surrender and if you are a basic rate taxpayer you can benefit from a relief called top slicing relief. This allows you to take the gain (plus withdrawals) and divide it by the number of complete years. You then add that figure to your income and if you are still a basic rate taxpayer, you will have no further tax to pay. Even if you were a higher rate taxpayer for some or all of the previous years you held the investment. If some of the amount takes you into higher rate, then that amount is multiplied by the number of years and higher rate tax is payable (only the difference as basic rate is already considered paid).

Offshore bonds are very similar but partial withdrawals are handled differently and of course no basic rate tax is paid during the investment.

Offshore bonds are particulary useful for those with large investments but low income as you can create chargeable events over the years to use up personal allowances and keep your tax low. Charges tend to be better with larger amounts (500k plus).

Onshore bonds are useful for higher rate taxpayers who will be basic rate in future or those over 65 with income close to £20,900 who would suffer an age allowance reduction if they had their money in a savings account or other income/interest generating product. Also useful for those equity investors who use their CGT allowances often and want to invest without impacting on their personal CGT liability. Active investors who switch investments a lot would also benefit from bonds as there is usually no switching charges and no CGT or chargeable event on a fund switch within a bond.

Investment bonds are also not included in the means test for local authority care or pension credit (providing you are not taking income from them - the income is included). They are also useful in IHT planning when used in conjunction with trusts.

When used in the right circumstances investment bonds can be invaluable and safe a fortune. Often many hundreds of thousands of pounds has been saved in tax with good use.

System

dunstonh thanks for the explanation.

My husband is considering his options regarding a lump sum he is due to receive when he takes early retirement (at age 49) and we read the article I mentioned but it didn't specify offshore or onshore. He is currently a higher rate taxpayer but will be basic rate when he retires and receives his pension.

It sounded useful if he could top up his monthly income by drawing out some of his investment.

EdInvestor

Watch out for high charges on these bonds and penalties for cancellation in the first 5 years.

Basic rate taxpayers are almost always better off to invest using their ISA allowances and then directly into equity unit trusts, as there is no further tax to pay for BRTs on dividends and there is a big annual allowance of more than 9k covering any realised capital gains (no tax on unrealised gains).

By contrast tax paid within the bond on capital gains cannot be reclaimed, leaving the BRT worse off..

dunstonh

Watch out for high charges on these bonds and penalties for cancellation in the first 5 years.

Those who do not visit the investment forum wouldnt know that Ed is our resident idiot when it comes to investment bonds. She is the same person that last year told a poster that it was better to have an IHT bill upto £200k rather than have an IFA earn a few thousand pounds to avoid that tax bill.

Ed is the poster that tells people that investing in an investment bond with a typical annual managment charge of around 1.2% p.a. is more expensive than a unit trust charging 1.5%. With large amounts investment bonds can be dirt cheap. I did one last week with an reduction in yield due to charges of 0.6% p.a. over 10 years.

You can even get bonds that have no charges and allow you to invest in unit trusts with exactly the same as buying the unit trusts unwrapped. However, these are actually not that good value due to the increased allocation rates that can see upto 109% given (hence the 5 year tie in many have. You dont get given free money to then be able to take it out 6 months later without penalty).

Like any retail product, you get cheap ones and expensive ones. Some of the best bonds are extremely good value and wipe the floor with charges. There are some pretty naff bonds out there as well. You dont measure all the bonds by the worst example. Unless you are Ed that is.

Cook_County

dunstonh wrote: »

Those who do not visit the investment forum wouldnt know that Ed is our resident idiot when it comes to investment bonds.

I am not Ed, but reading this I certainly find the comment offensive. The obvious question to me if someone is selling me something and telling me I can get my own money back in 20 installments is what the cost is...in other words why are they flogging it to me?

So while used in the right circumstances bonds can and do have advantages, they seem to be flavour of the month purely because of the commission structures in many cases as against the best advice. Ed has rightfully played devils advocate with the recommendation on this occasion.

dunstonh

You would need to see the many threads in investment section where Ed spouts misinformation and inaccurate data time and again despite all the regulars pointing out her inaccuracies. You cannot believe how fustrating it is and my response comes from that.

We have threads in that section which point out the advantages and disadvantages, when they should and shouldnt be used but then Ed comes in and posts a ton of outright lies and SPIN to put people off them. We have had so many people confused with the misinformation and lies that Ed gives because she works on the assumption that unit trusts are always better than bonds.

Here is an example of a typical bond thread http://forums.moneysavingexpert.com/showthread.html?t=488489&highlight=investment+bond

Its one thing giving the pros and cons but if you only present one side of things and stack them up using the very worst examples to compare against the very best examples of the alternatives then you are not getting a balanced debate.

Ed posts a lot of useful information on the boards but there are a couple of subjects where she is totally blinkered and this is one of them. I personally like the discussions we have on most things but I dont like the way facts are ignored or manipulated (ie. comparing execution only on one product vs full advice maximum cost on a different product when comparing execution only on both should be done). I apologise for using the term idiot as that was out of order. However, I dont apologise for my fustration.

EdInvestor

Sorry to hear you're so frustrated dunstonh, I'm sure it will pass.

I'm afraid that I believe no apology is needed for posting about the questionable nature of many investment bond sales.They are the 2nd large cause of complaints to the Ombudsman after endowment mortgages.

There may be cheap IBs, but far and away the majority of the ones we see on this board are expensive compared with the alternative. They also involve many basic rate taxpayers paying taxes which they would avoid if they didn't use the bonds ( endowments are the same).Plus they often have penalties, and sometimes these aren't properly explained.

It seems that any time anyone with a lump sum to invest goes anywhere near an advisor, the first product that is mentioned is an investment bond.I would simply suggest that anyone who has this experience should be on the alert, particularly if there is no mention of the ISA allowance.

dunstonh

They are the 2nd large cause of complaints to the Ombudsman after endowment mortgages.

You need to put complaints in context and your data is wrong.

49% of complaints were about endomwents (46,134) and 13% about investments (12,429). Banking 21% and insurance 17%

product followed by percentage
mortgage endowments 49
current accounts 8.5
mortgage products 4.5
motor insurance 4.5
personal pension plans 4
whole-of-life policies 4
buildings and contents insurance 3.5
single-premium investment bonds 3
credit cards 3
loan protection insurance 2
loans other than mortgages 2
travel insurance 2
savings and deposit accounts 1.5
income protection insurance 1
other products 7.5

The FOS also put with profits bonds and structured products under the bond category and they have had their issues in recent years yet share little resemblance to a unit linked investment bond which is closer to unit trusts than anything else.

There may be cheap IBs, but far and away the majority of the ones we see on this board are expensive compared with the alternative.

We see good and bad. We have had the excellent NU portfolio step down bond and clerical medical bonds mentioned in recent times. It doesn't matter that the poor examples get mentioned more because that is the nature of the forums. Bad things get talked about more than good.

Even if they did buy an expensive one on full commission terms then its fair to assume that had that person been sold unit trusts instead, then they would have been on full commission terms as well. Comparing the bond to an execution only unit trust without mentioning you can do execution only investment bonds as well is not being fair to the posters.

It seems that any time anyone with a lump sum to invest goes anywhere near an advisor, the first product that is mentioned is an investment bond.I would simply suggest that anyone who has this experience should be on the alert, particularly if there is no mention of the ISA allowance.

I'm not going to deny that they are oversold. Low quality advisers and tied agents do tend to use it too often. However, you don't tell people not to take out a product because the 3% of complaints to the FOS relate to the product class (and may not even be the same product) or that because some people may get them sold incorrectly that everyone will be.

You should present the pros and cons. Instead you just post only the negatives and use the very worst examples against the very best of the alternatives.

Also, a low cost bond can save a lot in charges and make up the tax difference. Especially in funds which are heavily invested into income generating assets where the taxation on income is exactly the same as unit trusts. Larger investments are also more suited to bonds whilst smaller investments more suited to unit trust. Bonds are best priced at 100k plus and the tax advantages of a bond are more likely to be relevant with that sort of amount or higher.

EdInvestor

Speaking about tax, perhaps those higher rate taxpayers who are offered an investment bond really ought to look at what exactly is involved.

Some details:

http://www.hmrc.gov.uk/manuals/iptm/IPTM3830.htm

EdInvestor

dunstonh wrote: »

You need to put complaints in context and your data is wrong.

No it isn't.There has been a decline in the number of complaints about IBs (no doubt reflecting the stockmarket recovery), but they are still in second place after endowments:

2004 7222 complaints
2005 6281
2006 4541


FOS annual report