Exploring why they are an attractive option to mass-affluent investors
Onshore investment bonds appeal to investors for their lower risk profile and contribution to a diversified portfolio. Many investors have traditionally favoured a portfolio allocation of 60% equities and 40% bonds. This approach capitalises on the differing performances of these asset classes across varying economic climates—a particularly advantageous feature during periods of market volatility.
Recent changes in Capital Gains Tax (CGT) regulations have shifted the landscape, making investment bonds an increasingly appealing option. These changes particularly affect those who have traditionally maintained investments in Open-Ended Investment Companies (OEICs) and unit trusts.
Investment bonds offer a range of benefits that enhance their attractiveness. For instance, onshore bonds are not subject to CGT. When calculating a chargeable gain, these bonds are treated as having already paid a 20% tax on any gains—although in practice, the tax deducted is often less than this amount.
Onshore investment bonds can also play an important role in Inheritance Tax (IHT) planning. If placed in an appropriate Trust, these bonds become exempt from IHT after seven years, an advantage that similarly applies to other assets or investments gifted into trust, such as OEICs and unit trusts. This benefit is invaluable for those looking to optimise their estate planning strategies.
Another key feature of investment bonds is the ability for investors to withdraw up to 5% of their initial investment each year without triggering a chargeable event or immediate tax liability. This benefit remains applicable until the total amount invested has been fully withdrawn in this manner and is similarly available for other trust-held assets.
Tax efficiency through top-slicing relief
Investment bonds also provide tax efficiency through top-slicing relief, which can substantially reduce or eliminate tax liability when a chargeable event occurs. This feature mainly benefits investors in the accumulation phase preparing for retirement. Typically, an investor might be a higher-rate taxpayer while holding the bond but a basic-rate taxpayer upon encashment, thus reducing tax obligations.
The flexibility of transferring ownership is another feature of investment bonds. For example, bonds can be assigned between spouses as a genuine gift. For tax purposes, this assignment is generally considered as though the new owner had always possessed the bond, potentially resulting in no tax liability upon encashment if the recipient is a basic-rate taxpayer.
Responding to broader tax changes
The adjustments to CGT and the tax-free dividend allowances will likely appeal to investors seeking to mitigate IHT liabilities and those who have already maximised their Individual Savings Account (ISA) allowances or received significant windfall payments. These changes underscore the strategic value of incorporating onshore investment bonds into a financial and investment planning strategy.