© 2019 A&J WEALTH MANAGEMENT LTD

A&J Wealth Management Ltd is authorised and regulated by the Financial Conduct Authority. Financial Services Register, no 428590, at www.fca.org.uk/register
Registered in England, Company no: 5105933. Registered Head Office: Sawfords, Bigfrith Lane, Cookham Dean, Maidenhead, Berkshire SL6 9PH

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Investment Bonds

 

Offshore Bonds

 

Offshore bonds are generally issued by subsidiaries of well-known UK life offices in countries such as Luxembourg, the Channel Islands, or the Isle of Man. Although onshore and offshore bonds are structured in similar ways, the tax treatment of the two types of bond is different.

 

The perceived advantage of offshore bonds is that the country concerned imposes little or no tax on the income and gains if the underlying life fund, thus allowing what is often called a gross roll-up that is valuable, particularly to a higher rate taxpayer. This contrasts with an onshore bond, where the fund suffers tax at up to 20% on income and on gains.

 

The effect of gross roll up can be reduced by the fact that charges are often higher for offshore bonds than for their onshore counterparts, and some investment income may be received after the deduction of non-reclaimable withholding tax.

 

UK Policyholders with offshore policies are liable to income tax at their highest rates on the whole of their gain, with some relief for any periods spent outside the UK during the term of the policy.

 

When an offshore bond pays out and a gain arises, there is a chargeable event for income tax purposes because it is a non-qualifying policy. The gain is calculated by multiplying the total gain by the number of days the policyholder was resident in the UK divided by the number of days of the policy term.

 

Therefore the whole gain is chargeable if the policyholder was resident in the UK for the whole term of the policy. If they were resident for 5 out of 10 years a policy was held, only half the gain is chargeable and if the policyholder was resident outside the UK the whole time, the chargeable gain is zero.

 

There is no time apportionment if the policy has ever been held by a non-resident trustee – in such cases the whole gain is chargeable.

 

Taxation

 

When a UK policyholder enchases an offshore bond, two separate calculations are carried out and the resultant tax is totalled:

  1. Basic rate tax calculation – for basic/higher rate taxpayer, the whole gain is charge to tax at 20%. If the policyholders other income is so low as not to reach the basic rate band, any part of the gain that falls within the personal allowance would not be subject to tax. As chargeable events are subject to the savings rate of income tax, the starting rate of 10% will apply.

  2. Higher/additional rate calculation (same way as onshore bond) – the gain is top-sliced and added to the policyholder’s other income. When the tax on the slice has been calculated it is multiplied by the number of relevant years to determine the total higher rate tax payable on the gain.

The number of years used for top-slicing is also reduced by the number of complete years for which the policyholder was not resident in the UK if applicable.

 

A chargeable gain on an offshore policy is always top-sliced by reference back to the inception date of the policy, even for part withdrawals. This is in contrast to a UK bond where part withdrawals are always top-sliced by reference to the number of years since the last chargeable event, each chargeable event effectively rebasing the date of the policy for top-slicing purposes.

 

Offshore Bonds vs. Onshore Bonds

 

Gains made by an onshore fund still benefit from indexation relief, with the net gain being taxed at 20% under the chargeable gains rules on encashment by a higher rate taxpayer. With an offshore bond, gains are taxable at 40% on encashment with no indexation allowance.

Some investment income received by an offshore fund may be received after deduction of non-reclaimable withholding tax, thus reducing the effect of the gross roll up. In addition, there would be no credit for this in the chargeable gin, leading to possible double taxation.

Charges on offshore bonds are generally higher than onshore ones, which will reduce the final net return received by an investor.

In an onshore fund, management expenses may be deductible from the fund’s income for tax purposes. An offshore fund has no tax from which to deduct management expenses, thus reducing the effect of the gross roll-up.

On an onshore bond, for a higher rate taxpayer 20% tax is charged on the net return of the fund, whereas on an offshore fund the 40% is on the gross return. One advantage of an offshore bond is that income can roll up gross. In theory, over the long term, the compounding effect could make a difference to the eventual overall return, despite the higher tax on final encashment.

However, this advantage is generally only gained over an extremely long-term or where the fund is invested in interest bearing assets. An offshore bond could, however, be advantageous if the investor expects to be non-UK resident for part of the term of the investment.

Onshore Investment Bonds

 

A Life Assurance Bond is an investment offered by a Life Assurance Company without a maturity date and therefore may be considered “whole of life” product. Bonds are normally established on using a single premium investment although it is possible to make additional contributions into it during the term.

 

A Life Assurance bond product is a flexible method of investing capital with the potential for growth over the medium to long-term.  It is designed to allow the policyholder’s capital to grow whilst providing the option to take tax efficient withdrawals.  The bond is structured as a life assurance policy and this offers the opportunity to take advantage of certain tax benefits dependent upon your personal circumstances and requirements. 

 

Typically, investment will be made into the unit linked funds offered by life assurance companies and these funds will be typically referred to as mirror funds and replicate direct investment funds managed by external fund managers. The insurance company will undertake to deduct a level of taxation from the underlying fund and equally additional charges may be taken. Dependent upon the insurance company that is selected the availability of investment funds will be chosen by the insurance company.  This can vary significantly and therefore is a very important consideration in selecting a particular company.  The greater range of funds provides for greater flexibility and enhanced potential returns. 

 

Income & Return of capital

 

The investment allows for a 5% withdrawal of the original capital per year without any immediate liability to taxation as this is considered a return of capital.  However, should a greater sum than 5% be withdrawn this could incur a chargeable event.

 

If the policyholder is a higher rate taxpayer or the income taken pushes those into the higher rate tax bracket additional taxation may be incurred.  When the Investment Bond is encash any investment growth achieve may be subject to income tax.

 

Withdrawals made can pay an income on a monthly, quarterly, half yearly or annually basis.

 

Charges applicable

 

Charges applied can typically be an initial charge of up to 5% of any capital investment lump sum made into the Capital Bond, a “platform charge” being the fee levied by the Provider / Life Office for providing the Plan which may range between 0.35% and 1%, and a fund level annual management charge between 0.25% and 1.8% - these charges cover the cost of managing the investment portfolio within the fund and will include stockbroker commissions, trail commission to financial advisers, stamp duty and operating costs.

 

These charges apply for open-ended investment schemes and for other investments there may not be any fund management charges. Typically these charges will be deducted on a daily basis. If you invest in an OEIC or a single-priced unit trust, there is no difference between the buying and selling prices. Any initial charge is deducted by the fund manager as a separate explicit charge, before your money is invested.

 

The value of a Bond will fluctuate in line with the underlying fund investments so can go down as well as up. If at some stage you were forced to sell the Bond as you needed access to the proceeds and this was during a period of adverse market

Tax on withdrawals

 

Basic rate tax is paid by the provider of the Capital Bond at a fund level dependent upon the income withdrawn from the investments within the fund. Therefore unless the policyholder is a higher rate taxpayer there is no further tax liability.

 

An additional higher rate tax liability may arise as the result of the following:

  1. The bond being partially or completely encashed;

  2. Withdrawals exceeding 5% and when added to other income this exceeds the threshold for basic rate tax;

  3. Death of the person assured;

  4. The policy is assigned to someone else.

 

Each policy year, the policyholder can withdraw up to 5% of the contributions made into your bond without having to pay income tax at the time of the withdrawal. The maximum amount that can be taken over the lifetime of a bond using the tax relief allowance must not exceed the total amount invested.  Any unused allowance in a given tax year will be rolled over to successive years. 

 

It is possible to withdraw more than 5% each year, or more than you have invested. This would cause a ‘chargeable event’ and the policyholder may then be liable for income tax. In this case the Provider will send the policyholder a ‘Chargeable Event Certificate’ which provides the information needed to complete a tax return (if necessary). Chargeable gains (those gains subject to tax) within the Bond are subject to income tax and not capital gains tax.

 

If a chargeable event is incurred any additional income taken above the 5% allowance will be subject to ‘top-slicing’. Given that the investment growth was achieved over a number of years it would be unfair for the amount withdrawn to be subject to tax in just one year.   

 

The gain achieved is divided between the number of years the bond has been in force and added to their income for the tax year the chargeable event is occurred. If the additional tax liability were to fall within the individual’s basic rate tax band no further income tax would be payable.

 

Where part of the top-sliced gain falls into the basic rate band and part falls into the higher rate tax band, only the proportion that falls in the higher rate is taxable at the higher rate i.e. an additional 20% income tax payable.

 

Tax on full surrender or death

 

If the Capital Investment Bond is fully cash in (surrender), or if the bond comes to an end as a result of death of the life assured, there may be a liability to income tax on any gain. Again this would be subject to top slicing rules.

 

Tax on income

 

The Life Office provider makes charges to reflect its liability to tax on distributions received gross from assets held on behalf of their policyholders. This applies to funds domiciled outside of the UK and is charged at a rate of 10% for distributions from funds largely invested in equities and 20% for distributions from funds invested in fixed interest securities. This accounts therefore for the basic rate tax liability within the Bond.

Death Benefits

 

On death of the Life Assured the amount payable is typically between 100% and 101% of the market value of the investments held within the Bond.

(The Life assurance element is normally limited to 1% of the value of the contract).

 

Putting Your Bond into a Trust

 

If you chose to put your bond into trust, the Provider will make any payments to the trustees.   If you were to put your bond into trust for inheritance tax purposes, it may mean that there are restrictions on some of the features of the bond. It is important that the trustees ensure that any changes made to the bond do not breach trust rules