Did you know that roughly 38% of Brits hold some form of investment, according to data from HSBC UK?
You may well be familiar with financial products such as Individual Savings Accounts (ISAs) and pensions, but what about investment bonds? For starters, what is an investment bond exactly?
Let Rose Financial Services explain.
- Investment bond [noun]: (in the UK) a single-premium life insurance policy linked to stocks and shares or other asset classes for long-term investment.
How do investment bonds work?
You give a lump sum of money to a life insurance company. They invest it for you, usually in a range of funds.
Over time, your money has the potential to grow. Usually this type of investment is for the medium to long term.
When you cash it in later, you might have to pay some tax on the profit you’ve made based on your tax status.
How are investment bonds different to other investments?
If you’re thinking about investing, you might also be considering ISAs.
- The main difference between ISAs and investment bonds is that ISAs are a tax-free investment and a way to save and invest your money up to a certain limit.
- Bonds may be liable to tax based on the type of bond and an individual’s tax status.
Onshore vs offshore bonds
An onshore bond is issued by a UK life insurance company. The funds within it are subject to UK tax internally, which the provider handles on your behalf. As a result, when you eventually make a gain, you're treated as having already paid the equivalent of basic-rate tax. Basic-rate taxpayers often have no further tax to pay on a gain, while higher and additional-rate taxpayers may owe the difference.
An offshore bond is issued by a company based in a jurisdiction with a favourable tax regime, typically the Isle of Man, Dublin, Luxembourg or the Channel Islands. Crucially, the funds within an offshore bond grow largely free of tax internally, a feature known as ‘gross roll-up’. This allows the full return to compound without the annual drag of internal tax.
The 5% withdrawal rule and chargeable event taxation
A big advantage of investment bonds is that you can take withdrawals of up to 5% of the original investment every year, without having to pay an immediate tax charge: tax-free bonds UK. These withdrawals are treated as a return of capital – the tax is deferred and only becomes payable when the bond is cashed in or matures, if any liability arises. Any unused withdrawal allowance can be carried over to the following tax year.
Withdrawing more than the 5% allowance would result in a chargeable event. The excess amount that’s been withdrawn would be a chargeable gain and could be subject to income tax.
Risks and suitability considerations
As with most investments, bonds come with risks. It all depends on stock market performance. If you’re looking for a tax-efficient investment, you need to weigh up your financial goals, tax bracket, and timeframe.
To find out if an investment bond is a good move for you, get in touch with Rose Financial Services' London-based advisers.
