Investment bonds – a flexible investment vehicle which falls outside capital gains tax

23.10.2024
Christopher Egmore
Financial Planning
Chris Egmore

Chris Egmore of Lovewell Blake Financial Planning says that onshore investment bonds can be a tax-efficient and simple way of investing for the medium- to long-term

Chris Egmore

With capital gains taxes almost certainly to be under the spotlight of the new Chancellor, finding ways to invest which will fall outside the reach of CGT is becoming something of a common theme.

Of course, ISAs are the obvious first place to look, as gains made within these are currently exempt from both capital gains and income tax.  But although the annual ISA allowance of £20,000 can be used over a number of years to invest a decent sum, for larger amounts, investment bonds can be an attractive additional tool in the investor’s armoury.

Investment bonds are actually classed as a ‘single premium life insurance policy’, because they include a (usually very small) element of life insurance.  But they are really an investment product – but one which, because of that life insurance element, are not subject to capital gains tax.

Instead, gains made in an investment bond sit in the income tax lane, but with two key advantages: that tax can be deferred until there is what is called a ‘chargeable event’ (more on that in a moment); and because such bonds are subject to UK life fund taxation, holders are treated as if they have already paid basic rate tax on any gain. 

So if you are not a higher or additional rate taxpayer, there is no further income tax to pay on any gain either (if you are a higher or additional rate taxpayer, you will be liable for the difference between the basic rate and your highest rate of income tax in the tax year in which the ‘chargeable event’ occurs).

Another big benefit of such investment bonds is the flexibility to withdraw up to 5% of the initial capital each year, with no immediate tax liability (this is regarded as withdrawal of capital).  This can be a useful way of creating an ‘income’ while deferring any tax liability until a much later date.

Any tax liability on gains made within the bond become payable when there is a ‘chargeable event’.  This could take a number of forms:

  • Withdrawing more than 5% of the amount you have paid into the bond in any one year (although you can carry forward any allowances from previous years if you have not taken the full 5%)

  • If you fully cash in the bond

  • The bond matures (if it is not a whole life bond)

  • On your death

  • In certain circumstances where you might transfer the ownership of the bond (for example as part of a divorce settlement) – although they can be assigned between married couples 

An investment bond is essentially a wrapper, in which you can invest in a range of funds, a portfolio, or a mixture of the two. Most bonds allow you to switch between funds within the bond as the years pass. These potential switches would also not be subject to taxation which is also a very useful feature that is not available with some other investments.

As ever, the suitability of investment bonds and investments will depend on your individual circumstances.  The attraction of a vehicle where there is flexibility to withdraw capital, which is outside the remit of capital gains tax, and where gains for basic rate taxpayers are free of any further income tax, means that investment bonds should certainly be something you discuss with your adviser when planning your investment strategy.

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