This article provides a high level summary of the potential advantages and disadvantages of UK bonds.
There are many considerations which may influence any advice. These may include:
- Risk profile
- Fund choice
- Future aspirations and objectives
These are client specific and as such form a key part of any recommendation made.
Taxation of the UK bond
Single premium investment bonds are taxed under the chargeable event legislation, (except for Corporate investors where the loan relationship rules apply), which means chargeable gains are assessed to income tax rather than capital gains tax (CGT).
The bond suffers corporation tax inside the life fund. The actual rate paid within the fund will vary but the bondholder will be deemed to have paid tax in the fund at a rate equal to 20% even where the rate is actually lower.
Capital gains occurring within the life fund are taxed at 20% but will benefit from indexation relief. This was removed for individuals in 1998 but life funds still benefit from this relief and will continue to do so.
UK dividend income received suffers no further tax, and all other income received suffers 20% though savings income will have had tax deducted at source.
Taxation of the bondholder
Higher and Additional rate tax payers will have a further tax liability on encashment. As a result of the life fund taxation already suffered a higher rate (40%) taxpayer will pay an additional 20% on the gain and an additional rate (45%) taxpayer will pay an additional 25% on the gain.
For basic rate taxpayers there is no further liability as the tax already suffered satisfies their tax liability but there is no opportunity for starting rate or nontaxpayers to reclaim any tax paid or use any unused personal allowance.
Where the gains move an investor from one tax band to another top-slicing relief may be available to reduce (or even remove) the additional tax liability.
Joe Reading earns £30,000 and has incurred chargeable gains of £20,000 on an investment he has held for 4 years. The full gain moves him from a basic to a higher rate tax payer, however, the top-sliced gain, being the full gain divided by the full number of years the investment has been held (£20,000/4 = £5,000), keeps him within the basic rate tax band and he has no further tax to pay.
Advantages of the UK bond wrapper
- Bonds are nonincome producing assets so there are no annual tax returns for individuals or trustees.
- Funds can be switched within the bond without giving rise to a CGT or income tax liability on the investor and with no tax reporting requirements.
- Switches in and out of funds are not subject to the CGT 30day rule so will not give rise to a taxable event.
- Realised gains may benefit from topslicing relief which can reduce or remove any higher or additional rate liability.
- Topups will benefit from topslicing from inception (individuals only).
- The bond can be assigned by way of gift without giving rise to a tax charge although there might be inheritance tax (IHT) considerations.
- 5% tax deferred allowance of the original investment can be taken each year for 20 years without creating an immediate tax liability.
- Can be gifted into trust and assigned out of trust without giving rise to an income tax or CGT charge.
- Multiple lives assured can be used at outset to avoid a chargeable event on death of the applicant(s).
- Single premium investment bonds are not normally included where means testing is applied by a local authority for residential care.
Disadvantages of the UK bond wrapper
- No tax reclaim for the tax paid by the life fund for starting rate taxpayers or non
- Base cost of investment is not revalued on death for income tax purposes
- (chargeable event gains are assessable against original investment).
- Death of last of the lives assured will cause the investment to end and create a chargeable event (even if bondholders are still alive).
- As withdrawals from a bond are assessable to income tax it‘s not possible to use a personal or trustee CGT allowance to reduce gains.
- The availability of personal allowances and eligibility for the child benefit charge will be impacted by the full chargeable event gains, not sliced gain.
- May not be a suitable investment for trustees where an ‘income’ on interest exists inside a trust.
- Investment losses cannot be offset elsewhere. On death, income tax and IHT may be due.