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Onshore bonds: still going strong

Charges would have to be taken into account to ascertain the actual returns for an investor and these will include wrapper charges for the bond or platform, specific fund charges and any adviser charges.

And before you say it, yes these figures are based on assumptions, but the point we are making is that wrapper choice depends on the circumstances, both at the time of the investment and on exit.

Equally, you cannot make an arbitrary statement about which is the best investment without bearing in mind the asset allocation, the rate of return and personal tax details of the investor.

Using the annual exemption each year

One of the advantages of collective investments is that you can bed & breakfast them every year to use the annual CGT exempt amount. Although nowadays you have to wait 30 days before reinvestment or reinvest in different holdings to use that facility and this can make this exercise difficult and possibly costly in practice. Considerable ongoing portfolio management is required to use this oft-touted advantage, which may not be appropriate for the smaller investor.

Higher rate taxpayers get a tax cut

What rate of tax do higher rate taxpayers pay on their onshore bond returns? 40% of course?

Well, not exactly. Because the life company pays corporation tax in the fund and then the policyholder pays tax on the net surrender value at 20%. The overall effective rate suffered by the investor investing through an onshore bond is thus made up from the tax on non-dividend income and gains at life fund level plus a further 20% personal tax on the gain realised net of any life fund tax. This will often be significantly less than 40%.

For example, to the extent that the growth in the value of the bond is contributed to by dividends there is no tax at fund level and 20% on the net gain realised. For other income, it’s 20% in the fund plus 20% personally on the net realised gains driven by this income. And for capital gains, it’s 20% on the gain realised from the bond but the net gain contributing to the realised gain will have benefited from indexation relief at fund level.

The effective overall rate of tax suffered by even a higher rate taxpaying investor on the gain realised under an onshore bond can thus, depending on the circumstances, be significantly less than that suffered through direct investment.

You can’t top-slice a capital gain

For many investments, tax planning is all about deferring or minimising ongoing taxation and then having a tax-efficient exit strategy.

And investing through collective investments and onshore bonds is no different. But one difference between them is that the capital profit on encashment can be averaged throughout the life of an onshore bond – to get an effective tax rate – but can’t be for collective investments.