Selecting a wrapper

Selecting a wrapper

In the past, some advisers have avoided the use of onshore investment bonds, and some still do. The image of bonds may have been tarnished in the past, however, the days of high allocations and commissions are gone.

It is important to put these factors aside and look objectively at the benefits onshore bonds can provide. They are a valuable planning tool and a good addition to a professional adviser’s portfolio of investment solutions. 

The desire for transparency over recent years has led many bond providers, such as Canada Life, to adopt a simple charging structure allowing clients to see clearly what they are paying and to whom.

Platform providers now also provide transparent unbundled charges too. 

The new transparent world makes it much easier for advisers and clients to compare the cost of different tax wrappers. 

The Select Account uses a single tiered product charge based on the value of the investment, similar to some platform providers. So, for example, a £250,000 investment has a monthly charge equal to just over £900 a year, or 0.36% of the investment. This is very competitive when compared to buying a collective on some platforms, where the annual platform charge can go up to 0.50% or even higher. 

Internal tax

With onshore bonds the gains and income achieved by the underlying life fund is subject to tax, paid by the provider and, whilst some may consider this a disadvantage, it can be very beneficial as it allows personal tax to be deferred. This can actually help an investor pay less tax overall which is not necessarily a bad thing.

To understand this, the tax paid within the fund is as follows:

  • Any interest and rental income received by the provider is subject to corporation tax at 20% although any UK dividend income received is not taxed. 
  • Any realised capital gains are also subject to corporation tax of 20% and for equities, equity-based investments and gilts, this is after indexation relief in line with the retail prices index. There is no indexation for other fixed interest holdings.
  • In addition to this for certain holdings such as equity-based unit trusts and OEICs, each year it is deemed to have disposed of the holding and reacquired it at the market value. These gains and losses can be spread over a seven year period.

From an investor’s perspective, this tax is deemed equal to basic rate tax, despite the fact that the actual tax paid is generally lower than 20%. It could potentially be a lot less, depending on investment performance and economic conditions.

Personal tax for your client

As there is no ongoing personal tax liability for the policyholder, a bond is easy to administer and a lot less hassle than some other forms of investment. This can be attractive to clients and especially to trustees who want to keep the ongoing administration to a minimum.

A tax calculation is only required when a gain is realised on a chargeable event. This could be when the last surviving life assured dies, the policy is fully surrendered, there is a withdrawal in excess of the cumulative 5% tax-deferred allowance or if the bond is assigned for money or money’s worth. It can also occur on maturity but most bonds do not have maturity dates.

Let us look at an example of how this works. Eric is aged 50 and he invested £100,000 over a period of 8 years and his annual income when he surrenders the investment is £30,000. For simplicity let us assume that the money is invested in a growth fund.

Investment bond

Unit trust/OEIC

  • The bond grows to £148,000 and when surrendering the bond a gain of £48,000 is realised.
  • Adding the gain increases the income to £78,000.
  • As the total gain takes the client into the higher rate tax threshold, top slicing allows the gain to be spread over the number of years it has been made.
  • £48,000 growth over 8 years gives an annualised gain of £6,000 each year.
  • Remember, their tax position in the year of the gain is treated as being their tax position in each year of the investment.
  • Adding the top-sliced gain to their income in the final year, gives income of £36,000.
  • After allowing for the personal allowance, their income remains within the basic rate tax threshold of £45,000 and, as basic rate tax has already been deemed to have been paid, then there is no additional tax to pay.
  • As there would not be any tax within the fund, let us assume the growth is slightly higher than a bond and the investment is worth £153,000.
  • On final encashment, a gain of £53,000 is realised
  • After deducting the annual exemption of £11,300, the taxable gain is £41,700.
  • When added to the client’s income, £15,000 falls within the basic rate tax threshold and is taxed at 10%, or £1,500.
  • The balance of the gain is £26,700 and will be subject to 20% tax, being £5,340.
  • The total liability to the client is £6,840, leaving a net gain of £46,160, less than that achieved by the bond.

This is quite a difference in the tax position for a simple example. Some will say that, with a collective portfolio, the client could use the annual capital gains tax (CGT) exemption each year to reduce the potential CGT liability and this is prudent planning. But this involves calculating the capital and growth of each disposal from each fund. This will come at a cost and may not actually be done each year.