Investment bond taxation

dunstonh

A common subject on these forums and one that often results in heated debate. In an attempt to clear it up once and for all, I have a link to the FSA publication on projections and on page 50 it covers life funds.

http://www.fsa.gov.uk/pubs/other/projection_rates07.pdf

It states:

Life funds bear tax on income and capital gains. Our analysis suggests that for a typical mixed fund, the reductions in respect of tax from the illustration rates of 5%, 7% and 9% in current use might vary from 0.4% for the lower illustration through 0.8% for the central assumption to 1.2% for the higher illustration. However, it should be noted that asset allocation, rate of churn, rate of return and proportion of return derived from income all have an effect on the tax payable.

So, at 5% return the effect of tax is 8%. At 7% return it is 11% and at 9% return it is 13%. Not 20% which is the theoretical maximum.

As has also been said in the past, if you are a low risk investor or medium risk the bond may be more suitable to you than a higher risk investor if you are a basic rate taxpayer. If you buy the bond on comparable terms (i.e. like for like distribution channels) then that difference of 0.4-0.8% can easily be offset by the lower charges in the investment bond.

The asset allocation has an impact on the suitability of the product as much as anything else.

Time to kick off another debating thread.....

jem16

dunstonh wrote: »

In an attempt to clear it up once and for all, I have a link to the FSA publication on projections and on page 50 it covers life funds.

Ever the optimist.

So, at 5% return the effect of tax is 8%. At 7% return it is 11% and at 9% return it is 13%. Not 20% which is the theoretical maximum.[/LEFT]

I must be having a thick moment but can't work out where this comes from after you said this;

Our analysis suggests that for a typical mixed fund, the reductions in respect of tax from the illustration rates of 5%, 7% and 9% in current use might vary from 0.4% for the lower illustration through 0.8% for the central assumption to 1.2% for the higher illustration.

Can you explain please?

dunstonh

I must be having a thick moment but can't work out where this comes from after you said this;

Just checking my figures as I may have got carried away in enthusiasm...

0.4% (taxation) / 5% (return) = 8% (tax rate applicable at that level of return). Remember that 20% has been the often quoted figure as the amount extra that is paid. The figures show that 8% (For lower rate) rising to 13% (for higher rate projections) is closer to the mark (1.2%/9%=13%).

jem16

dunstonh wrote: »

Just checking my figures as I may have got carried away in enthusiasm...

Nothing wrong with your figures - just my brain turned to mush at the moment with endless Christmas fun with the kids at work.

Couldn't figure out whether to add, subtract, multiply or divide. :rolleyes:

Remember that 20% has been the often quoted figure as the amount extra that is paid. The figures show that 8% (For lower rate) rising to 13% (for higher rate projections) is closer to the mark (1.2%/9%=13%).

I must remember that for next time it appears in an argument - and I have no doubt that it will.

dunstonh

I must remember that for next time it appears in an argument - and I have no doubt that it will.

Ed has already quoted 20% in another thread at 6pm (4 hours after this thread started). I think you were right about being optimistic.

EdInvestor

It was quite amusing reading what some of Dunstonh's more advanced IFA colleagues thought about this subject today.

http://www.citywire.co.uk/Blogs/BrokerConsultants/Entry.aspx?VersionID=99673

Clearly they held the FSA view in some derision.Not to mention the product itself, of course.

dunstonh

what some of Dunstonh's more advanced IFA colleagues thought

No need to be rude and you know nothing about my qualifications.

Clearly they held the FSA view in some derision.Not to mention the product itself, of course.

Strange as a number of them dont have that view and some are well presented.

The FSA figures are fairly consistent with other sources. 10% average is often quoted and I have seen the 1.2% extra quoted a number of times before (for 9% p.a. illustrations). Multiple sources come out with these figures but Ed chooses to ignore it and quote the theoretical maximum which ignores the tax credit on income and allowances and reliefs.

jem16

EdInvestor wrote: »

It was quite amusing reading what some of Dunstonh's more advanced IFA colleagues thought about this subject today.

How exactly do you work out from a list of names (some of whom don't even give a surname)who is a "more advanced IFA" ? In fact how do you actually know that any of them are IFAs?

Clearly they held the FSA view in some derision.Not to mention the product itself, of course.

What I read was a mixed bag of responses.

Can you also tell me why you frequently quote the FSA tables on investment bond charges as gospel and then rubbish the FSA publication on bond taxation?

EdInvestor

The FSA states that the following gains in an investment bond are taxed at 20%:

UK equity capital gains
Foreign equity capital gains
Foreign equity dividends
UK Corporate bond and gilt capital gains
UK gilt and bond income
Foreign bond capital gains
Foreign bond income
UK commercial property capital gains
UK commercial property income
Foreign commercial property capital gains and income
Cash interest.

The following gains are untaxed:

UK equity dividends.

That's it.

At an assumed growth rate of 7% the report estimates that returns will be reduced by 0.8% , but this depends on rates of churn and the mix of assets. At 9% they will be cut by 1.2%.This will in many case double the charges payable on the bond.

Note that over a 25 year period (an average retirement in future) a 1% charge will eat up 25% of your total returns on an investment. So if you are paying 1% in charges and 1% in tax, that's 50% of your returns gone.


Plus you have wasted your 9000 quid annual CGT allowance over the entire period.

These estimates confirm IBs are obsolete products.

jem16

EdInvestor wrote: »

At an assumed growth rate of 7% the report estimates that returns will be reduced by 0.8% , but this depends on rates of churn and the mix of assets. At 9% they will be cut by 1.2%.This will in many case double the charges payable on the bond.

So you pay no charges outside the bond do you?

From H-L website based on 6% return;

JPMorgan Natural Resources - RIY 3.9%
Artemis High Income - RIY 3.79%
Invesco Perpetual High Income - RIY 4.01%
Neptune Income - RIY 3.89%

My Investment Bond (not H-L) - RIY 4.8%

These estimates confirm IBs are obsolete products.

The above estimates prove otherwise.

EdInvestor

jem16 wrote: »

From H-L website based on 6% return;

JPMorgan Natural Resources - RIY 3.9%
Artemis High Income - RIY 3.79%
Invesco Perpetual High Income - RIY 4.01%
Neptune Income - RIY 3.89%

My Investment Bond (not H-L) - RIY 4.8%

Seems to confirm the FSA view - the taxes in your bond add around 1% or so on top of existing charges outside the bond.

Do you have a direct link to those RIY figures BTW?