Using an investment wrapper set up by a life insurance company in a jurisdiction with a favourable tax regime, such as the Isle of Man or Dublin, opens up a wealth of planning opportunities.
Investors benefit from growth that is largely free of tax as no tax is imposed on the income and gains in the underlying funds - this is known as 'gross roll-up'.
Growth may not be entirely tax free however due to the impact of irrecoverable withholding tax which may be deducted from interest and dividends received by the fund.
Each year an individual may be entitled to a personal allowance, starting rate for savings income and the personal savings allowance. But to get the most of the tax free allowances requires careful planning and timing. This is where the unique features of an international bond can aid tax planning.
The first thing to remember is a client can withdraw 5 per cent of the total amount invested each year without an immediate liability to income tax. This is known as the ‘tax-deferred withdrawal’ facility. Where the facility is not used in one year it can be carried over to the next year.
So, someone with £300,000 to invest could take, for example, £15,000 each year for a period of 20 years, or £12,000 (4 per cent) for a period of 25 years.
By splitting the bond into a number of ‘segments’ the client has the flexibility to fully encash segments rather than taking a withdrawal across the whole bond.
Remember, if a gain is realised from an international bond it is treated as ‘savings income’, so together with the personal allowance, the starting rate for savings allowance and the personal savings allowance, an international bond offers tax-efficient planning.
This means that a non-taxpayer can realise up to £17,000 gains without any personal liability to tax. This is made up of their personal allowance (£11,000 for 2016/17) and then the ‘starting rate for savings’ (£5,000) which is taxed at 0 per cent.
On top of that there is the personal savings allowance (£1,000 for 2016/17) although this is reduced to £500 for higher rate taxpayers. Additional rate taxpayers do not benefit from the personal savings allowance.
For basic rate and higher rate taxpayers top-slicing is an important tool that can be used where the total gain would take the client into the higher rate or additional rate tax brackets.
Top-slicing allows the gain to be proportioned over the number of complete years the bond has been in force. Remember, when dealing with international bonds top-slicing is always back to inception, irrespective of whether there have been previous chargeable events.
Assigning the bond or individual segments will shift the taxation onto the new policy owner. This can be a valuable planning opportunity especially if the new owner may be a non-taxpayer.
The fact that bonds can be assigned without a tax charge means owners that pay higher rates of tax could assign to a spouse or child who has little or no income to fulfil distributive functions in a tax-efficient manner. In effect, tax responsibility is passed to the recipient minimising administrative costs and ensuring an even-handedness of treatment.