Onshore investment bonds - rationale...

artyboy

I posted this on another thread earlier but as the title was just 'investments', I suspect it might get lost in the noise...

I'm curious about onshore IBs attractiveness, even with reduced CGT thresholds. Given the 5% annual withdrawal limit to stay free of income tax - unless you're investing a large 6 figure sum (or more), wouldn't you be able to take a similar level of income out of a normal GIA based investment with very little risk of exceeding your annual £3k CGT allowance - assuming it's not being used elsewhere?

A (significantly older) acquaintance of mine has been recommended one of these by their IFA (yes, definitely IFA!), single life, not written into trust, and whilst I'm not going to second guess anything, I'm just interested to know why it might be better than investing in a simpler and cheaper multi-asset fund (HSBC IB mix is 55% eq, 15% bonds, 30% cash) and taking an income from that. Apart of course from a preference to go advised rather than DIY?

Also... is 2.4% a reasonable initial charge for a lower 6 figure sum...? Ongoing advice fee is 0.5% so I'm not jumping to any conclusions about it being a rip off if there is significant work in setting it up.

dunstonh

Given the 5% annual withdrawal limit to stay free of income tax - unless you're investing a large 6 figure sum (or more), wouldn't you be able to take a similar level of income out of a normal GIA based investment with very little risk of exceeding your annual £3k CGT allowance - assuming it's not being used elsewhere?

5% is the deferred allowance.   You can surrender segments and the gain is treated under income tax (plus savings allowance).  So, they can be effective for nil or low earners (or future nil or low earners).  

The 3k CGT allowance means it is going to be very easy to break the annual allowance.  Even when doing a bed & ISA/bed & pension.

I was reading the latest platform annual report and the sales of offshore bonds are up 13%.   They have been in the doldrams for years because the old CGT/dividend allowances meant they were not really worth it other than for larger amounts and a few unusual circumstances.

I find it more useful in a multi-wrapper scenario.  

 I'm just interested to know why it might be better than investing in a simpler and cheaper multi-asset fund (HSBC IB mix is 55% eq, 15% bonds, 30% cash) and taking an income from that. Apart of course from a preference to go advised rather than DIY?

The MPS version of VLS and HSBC GS are generally better than the OEIC versions.   You can only get the MPS version via IFAs.     We tend not to use the MPS on GIAs though because of the CGT risks.  That isn't a problem with an offshore bond.  

The investment amount is going to be larger in your friend's case. So, you are pretty much guaranteeing dividend tax and CGT with a GIA vs assessment under income tax instead/savings allowance instead.     Your friend's income is going to be key.

Also... is 2.4% a reasonable initial charge for a lower 6 figure sum...?

Context with amount is important.  A lower 6 figure sum for some people may differ from yours.   So, 2.4% could be fine but it could be pushing it.

poseidon1

dunstonh said:

Given the 5% annual withdrawal limit to stay free of income tax - unless you're investing a large 6 figure sum (or more), wouldn't you be able to take a similar level of income out of a normal GIA based investment with very little risk of exceeding your annual £3k CGT allowance - assuming it's not being used elsewhere?

5% is the deferred allowance.   You can surrender segments and the gain is treated under income tax (plus savings allowance).  So, they can be effective for nil or low earners (or future nil or low earners).  

The 3k CGT allowance means it is going to be very easy to break the annual allowance.  Even when doing a bed & ISA/bed & pension.

I was reading the latest platform annual report and the sales of offshore bonds are up 13%.   They have been in the doldrams for years because the old CGT/dividend allowances meant they were not really worth it other than for larger amounts and a few unusual circumstances.

I find it more useful in a multi-wrapper scenario.  

 I'm just interested to know why it might be better than investing in a simpler and cheaper multi-asset fund (HSBC IB mix is 55% eq, 15% bonds, 30% cash) and taking an income from that. Apart of course from a preference to go advised rather than DIY?

The MPS version of VLS and HSBC GS are generally better than the OEIC versions.   You can only get the MPS version via IFAs.     We tend not to use the MPS on GIAs though because of the CGT risks.  That isn't a problem with an offshore bond.  

The investment amount is going to be larger in your friend's case. So, you are pretty much guaranteeing dividend tax and CGT with a GIA vs assessment under income tax instead/savings allowance instead.     Your friend's income is going to be key.

Also... is 2.4% a reasonable initial charge for a lower 6 figure sum...?

Context with amount is important.  A lower 6 figure sum for some people may differ from yours.   So, 2.4% could be fine but it could be pushing it.

Just an observation, OP was talking about Onshore bonds ( taxed at source at life company rates  in the UK ).
Would your comments on Offshore bonds apply to Onshore variants, bearing in mind basic rate tax payers will almost  always  have an income tax liability on offshore bond gains after exhausting their cumulative 5% withdrawals.

artyboy

Thanks Dunston - to be clear we're talking under 130k, and yes it's an onshore bond. The planned withdrawal rate is actually 4.5% (as I believe the other 0.5% headroom will pay the advisor fee), so we're literally talking about a 5k annual income from this.

Which is why I was thinking that income level, if taken from a GIA investment, would be very unlikely to breach the annual CGT allowance (assuming it's not being utilized elsewhere.

I do get that this is probably being set up to provide an 'invest and forget' mechanism that automatically pays out income, so if that is the requirement then job done. But it just seems more expensive and complex that I'd choose to go for.

As for overall income - BR taxpayer in retirement, with reasonable headroom before hitting HR tax.

Also, I just read that the income taken is only tax 'deferred' and not exempt. So if I'm reading this correctly, there will be a tax charge down the line, possibly at point of death? Not something this individual may be that bothered about, but if they were thinking about estate planning, maybe an undesirable consequence...

dunstonh

Just an observation, OP was talking about Onshore bonds ( taxed at source at life company rates  in the UK ).

Missed that bit.  Thanks...

Would your comments on Offshore bonds apply to Onshore variants, bearing in mind basic rate tax payers will almost  always  have an income tax liability on offshore bond gains after exhausting their cumulative 5% withdrawals.

Onshore bonds are treated as basic rate tax being paid but internally, depending on asset mix, would only be paying around 13%.

Thanks Dunston - to be clear we're talking under 130k, and yes it's an onshore bond. The planned withdrawal rate is actually 4.5% (as I believe the other 0.5% headroom will pay the advisor fee), so we're literally talking about a 5k annual income from this.

£130k doesn't really seem like bond territory.   It should certainly have £20k into ISA if the ISA allowance hasn't been used yet.  A bit into pension if under 75 too.

Internal taxation is around 13%, and you need to compare that to a GIA with dividend tax and CGT.  CGT is less than 13% (and it would only be on gains realised).  Dividend tax is less than 13%.   Ok, you get a bit of both put together but with annual bed & ISA of £20k (and possibly bed & pension of £2880), the amount of tax would be dwindling every year until ultimately, everything is in the ISA.   Onshore bonds suffer circa 13% every year.

 But it just seems more expensive and complex that I'd choose to go for.

It shouldn't be any more expensive than other wrappers (although sometimes a tiny bit, depending on platform).

Obviously, we don't have the full detail but based on the very limited info given, I am not seeing a standout reason that puts onshore better than GIA & ISA.

Bostonerimus1

As a rule of thumb I avoid investment funds wrapped in insurance policies as they always come with significant fees and complications along with any advertised tax advantages. You should be using pensions and ISAs first and I think you will need to be in a high tax bracket to even consider "Investment Bonds" as in anyway tax efficient. If I was being recommended an IB I would want to see detail calculations for my particular circumstances that showed all internal and external taxation amounts, fees and a comparison with a GIA, ISA and pension strategy.

dunstonh

As a rule of thumb I avoid investment funds wrapped in insurance policies as they always come with significant fees and complications along with any advertised tax advantages. 

Not in the UK.    

You should be using pensions and ISAs first 

Not necessarily in the UK.  There are scenarios where OB can be better before these.   Its scenario specific.

and I think you will need to be in a high tax bracket to even consider "Investment Bonds" as in anyway tax efficient.

That is one scenario where it can work out best.  But non earners are another.

 If I was being recommended an IB I would want to see detail calculations for my particular circumstances that showed all internal and external taxation amounts, fees and a comparison with a GIA, ISA and pension strategy.

There is software available to IFAs that do this.   

poseidon1

Bostonerimus1 said:

As a rule of thumb I avoid investment funds wrapped in insurance policies as they always come with significant fees and complications along with any advertised tax advantages. You should be using pensions and ISAs first and I think you will need to be in a high tax bracket to even consider "Investment Bonds" as in anyway tax efficient. If I was being recommended an IB I would want to see detail calculations for my particular circumstances that showed all internal and external taxation amounts, fees and a comparison with a GIA, ISA and pension strategy.

Agree re higher rate tax payer suitability. However I would also tend to look at them in the context of IHT mitigation products ( think discounted gift schemes and gift and loan plans) where their insurance based structure can have certain benefits.

 They also have advantages in the context of discretionary type trusts looking to accumulate over many years and avoid annual 45% income tax compliance and cgt record keeping ( which can be quite complex). 

By and large however, they should  probably be considered 'special purpose vehicles'  as indicated above rather than a product to be rolled out as generally suitable for ordinary basic rate retail investors. Agree Isas, GIAs and Sipps do a better more transparent job of work in most cases.

Bostonerimus1

dunstonh said:

As a rule of thumb I avoid investment funds wrapped in insurance policies as they always come with significant fees and complications along with any advertised tax advantages. 

Not in the UK.    

You should be using pensions and ISAs first 

Not necessarily in the UK.  There are scenarios where OB can be better before these.   Its scenario specific.

  

The extent of the complications and excess fees might be different between the UK and the US, but the OP does mention some fees that seem significant to me, but I'm cheap. 

The OP's friend might have the right set of financial parameters to make an IB a possible solution, but for most people there will be simpler and cheaper solutions and the OP's friend should definitely look at a comparison between the IFA IB and maybe a more direct GIA, ISA, SIPP combination.

artyboy

Just to add one more data point, too old for any tax efficiency from pension contributions... but yes, ISA/GIA does sound like a very viable alternative if they want to explore it... 

Thanks all.