Insurance bonds have always been a staple part of a financial planner’s toolkit, but there is no doubt that in recent years the use of general investment accounts has dominated.
Following changes to the UK tax landscape in the past few years, there has been a renewed interest in the use of onshore insurance bonds.
This resurgence in their popularity began in earnest with the 75 per cent reduction in the annual exempt amount (AEA) for capital gains tax and dividend allowance, announced in the 2022 Autumn Statement.
And now, as we approach the new Labour government’s first Budget statement, with potential changes to CGT being widely rumoured, interest in the use of this tax wrapper has once again peaked.
When investing, there are two basic things to consider when it comes to tax.
The first is how much tax you pay over your investment horizon and the second is at what point you will withdraw your money. At the end of the day, it is a combination of both of these things, in addition to any investment growth, that dictates your net return.
Taxation within a bond
With a GIA, income is generated every year, which creates an annual income tax liability, and a CGT event occurs when you sell down some or all of your investment.
You may have CGT events every year if you are managing a multi open-ended investment company portfolio and have to buy and sell investments over the investment horizon.
From what advisers are telling me, since the AEA reduced from £12,300 to £3,000, they are seeing more and more in-year CGT events.
One of the key aspects of an insurance bond is that it does not produce investment income. There is only a tax event for the individual when there is a chargeable event, for example when a policy is surrendered or the last life assured dies.
Taxation takes place on an ongoing basis within the bond wrapper under special corporation tax rules and so does not affect the individual. And for offshore bonds there is no ongoing tax and any tax impact on the individual only occurs when a chargeable event takes place.
The table below illustrates the tax treatment of the different components of investment return when held within an onshore bond and when held directly through the GIA.
Dividend | Non-dividend income | Gains | |
Tax in bond | 0% | 20% | <20%* |
GIA above nil rate bands | |||
Basic | 8.75% | 20% | 10% |
Higher | 33.75% | 40% | 20% |
Additional | 39.35% | 45% | 20% |
*In practice it is slightly lower due to expenses and other corporation tax rules.
It is clear that when it comes to dividends, taxpayers at all levels have the potential for greater tax efficiency within a bond. With non-dividend income, such as savings interest, higher and additional rate taxpayers benefit from only paying the equivalent of basic rate tax.
Gains are less efficient in the bond, as there is no AEA, and the rates are lower for basic rate taxpayers and neutral for higher and additional rate taxpayers outside the bond.
