Are Bonds still a good idea?

by Richard Allum on 1 April 2008

The case for and against Investment Bonds has raised for a long time and will continue to do so with most advisers and paraplanners polarised in their opinions. The changes to the CGT regime confirmed in the Budget seem, in may people’s eyes, to have settled the argument once and for all in favour of collective investments with a flat tax of 18% on capital gains in excess of the personal allowance (£9,600 for 2008/09).

This article is not going to side with either camp!

Unsurprisingly the life offices have put forward a robust argument in favour of Bonds. The Hartford has produced a glossy guide which puts forward the case for bonds which you can download by clicking here.

AXA has also issued its own views on the ‘many’ reasons why advisers should consider recommending onshore and offshore bonds which is shown below. [PLEASE NOTE – this is AXA’s opinion and not necessarily ours.]

In general

  • Basic rate taxpayers who invest in a bond should be no worse off after the Budget than they were before it happened, assuming that any top-sliced gain does not cause their taxable income to exceed the basic rate tax threshold.
  • Basic rate taxpayers could see an increase in the rate of Capital Gains Tax on collectives as any capital gain in excess of the annual exemption would be taxed at 18% rather than 12% where maximum non-business assets taper relief is currently available.
  • If the bond is encashed after retirement when taxable income is normally reduced (when the investor is a non or basic rate tax payer) there may be scope to eliminate or reduce the tax charge on any chargeable gain.
  • Various strategies can be employed to try to ensure that chargeable gains are kept within the basic rate tax threshold for onshore bonds, or to try to ensure that chargeable gains under offshore bonds are only subject to the starting or lower rates of tax.
  • Investors in a bond can assign their policies to people who fall into a lower tax bracket – a grandchild at university or a non-working spouse/civil partner, for example.
  • The underlying fund(s) of an onshore bond may incur corporation tax on the income it produces and capital gains (after allowance for indexation relief), but the tax could be charged at a rate that’s significantly below the 18% level for collectives, depending of course on the makeup of the fund(s). This will be particularly attractive to basic rate taxpayers or to people who won’t be subject to higher rate tax (after top-slicing relief) on encashment.
  • Collectives may not produce 100% of their return in the form of capital gains. A sizeable proportion of the return could be in the form of dividends, which in the hands of a higher rate taxpayer creates an ongoing annual income tax liability of 22.5% of the sum of the dividend and the notional tax credit.
  • Encashing individual policies within a bond over a number of years to take advantage of top-slicing relief will also continue to be relevant for many individuals in order to help eliminate or reduce the tax charge.

Offshore bonds

  • Investment gains in an offshore bond roll up free of Capital Gains Tax and income tax. The only tax which funds may be liable for is any tax deducted at source from dividend income and interest.
  • An offshore bond also brings potential benefits to clients who are planning to move abroad when they retire and may no longer be a UK resident for tax purposes.
  • Time apportionment relief is still available in connection with offshore bonds, and clients who have been or are likely to be a non-UK resident for tax purposes during the term of the bond will continue to be able to take advantage of this.

Inheritance Tax planning

  • Inheritance Tax planning remains a key market, and using bonds for insurance-based planning can still be very effective.
  • Using a bond as part of your clients’ Inheritance Tax planning can mean less administration and fewer complex tax considerations than if they used collectives.
  • Bonds can normally be assigned or gifted into trust with no Capital Gains Tax charge, whereas collectives may create a Capital Gains Tax liability at that time – although hold over relief may be available with certain trusts.

Drawing an income

  • Basic rate and higher rate taxpayers who invest in a bond can take up to 5% per annum of the initial amount they invested as tax-deferred withdrawals.
  • They can do this for up to 20 years without incurring a tax charge at the time they make the withdrawal.
  • If your clients do not want to take an ‘income’, the 5% per annum ‘entitlements’ can be accumulated for future use. Such withdrawals are taken into account on final encashment of the bond to see what tax (if any) should be paid.
  • The withdrawals from the funds as well as the capital value can fall as well as rise and is not guaranteed, furthermore, income in the form of regular withdrawals reduces capital growth potential and could cause the value of the bond to fall below the original investment amount.
  • Withdrawals of more than 5% per annum of the initial amount invested may be subject to an immediate tax liability. Withdrawals of more than 7.5% per annum of the value of the bond may attract early cash in charges

Administrative simplicity

As bonds are non-income producing assets, they:

  • May be very tax-efficient for clients aged 65 and over for whom the preservation of age-related tax allowances could be important.
  • Do not normally impact on tax returns. For instance, there must be a chargeable gain on part surrender or full encashment to necessitate entries on a tax return.

Switching funds

  • Gains from collectives that are in excess of the annual exemption will be subject to a flat rate Capital Gains Tax charge of 18%. So clients with actively managed portfolios could incur an 18% tax charge on any capital gains each time their investments are sold.
  • The compounding effect of tax-free switching in bonds can result in potentially higher gross returns, allowing more scope for greater benefits on encashment.

Trustee investments

  • Bonds are attractive as trustee investments for discretionary trusts and accumulation and maintenance trusts. By using the 5% per annum tax-deferred withdrawal facility to appoint capital to beneficiaries, it’s possible to reduce the complicated position that can arise when UK dividend income is received by such trusts and has to be distributed to beneficiaries.
  • Whilst collectives can be used to generate an ‘income’ by part disposals, please remember that trustees normally only get 50% of an individual’s Capital Gains Tax annual exemption and this may be split if the settlor has created other trusts.
  • As bonds are non-income producing assets, they do not impact on the settlor’s personal tax return or the trustees’ tax return unless there are chargeable gains. They should therefore help to simplify the administration of trusts.

Comment

At Adviser Assist we have certainly seen a significant reduction in the number of Bonds being recommended to clients in the last two years with collective investments within a fund supermarket or wrap account becoming more popular. There are still times when a Bond is still to be recommended but, as always, this depends on the suitability of a Bond to the clients circumstances. This should be the determining factor in the arguments as I think it is very difficult to have a ‘one size fits all’ approach.

{ 2 comments… read them below or add one }

UK Pension Transfer 28 August 2012 at 8:21

Hello There,
I totally like your views on Are Bonds still a good idea? | The Paraplanner and will be back again.

. Cheers..

vehicle app 14 December 2012 at 12:12

Thoroughly great article on Are Bonds still a good idea?

| The Paraplanner.
Always keep publishing.

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