Insurance bonds are still very much alive, dashing the predictions of observers who said that changes to the taxation of capital gains would finish them off for good.
Wealth managers say that although insurance bonds, also known as investment bonds, have lost some of their allure for UK citizens, there are still circumstances in which they can be useful, particularly for non-domiciled residents.
When the government altered the taxation of capital gains investments to a flat rate of 18 per cent rather than applying taper relief, there were repercussions across the investment world. Investment managers predicted that one of these would be a crash in sales of investment bonds.
The tax bill for investment in insurance bonds, which can be 40 per cent for higher-rate taxpayers, became effectively twice that of other investments such as unit trusts, which as of April are taxed at 18 per cent, with the first £9,600 of gains tax free.
Insurance bonds are single-premium savings contracts issued by life insurers. They work like unit trusts, putting funds into a collective investment run by an investment manager. But unlike unit trusts, onshore bonds are taxed as income, not capital gains. A basic-rate tax charge is incurred at source and is met by the insurance company.
They were traditionally one of the most popular forms of saving for retirement before the tax rules were altered.
But insurance bonds can still serve a purpose for those who are higher-rate taxpayers while working, but anticipate paying basic-rate tax in the future when they retire, says Mike Warburton, senior tax partner at Grant Thornton.
This is because the nature of investment bonds means the tax is due when the bond is cashed, not while the bond is still growing. The tax charge payable on this will depend on the level of income the investor receives at the time of encashment.
Although the basic-rate tax has been paid for by the insurance company, a higher-rate taxpayer will still be liable for the additional 20 per cent on encashment. For an investor with a profit of £120,000 this would mean a bill of £24,000.
If, on encashment, the investor’s income has dropped to the basic rate, the investor will pay no further tax on the profit.
Insurance bonds can also still be useful for inheritance tax planning purposes, as they can be written under trust. There is still the option to write the investment bond into a trust which is then signed over to a child or other basic-rate taxpayer. This allows the investment to continue to grow tax free and when the investment is sold the child, whose name the investment is in, will not be subject to higher-rate tax charges.
But the group that wealth managers expect will really start to embrace insurance bonds is wealthy foreign investors.
Investing in offshore insurance bonds allows investors to “roll up” the income they receive gross of tax, as the investment is not taxed at source.
This, say tax experts, is where the government’s new rules for non-dom taxation can be useful. Non-doms now have the choice between paying UK tax on investments they hold overseas or pay a flat annual fee of £30,000.
As the money in offshore insurance bonds is not taxed at source, non doms can choose to hold the investment in a wrapper which will allow it to grow free of tax while still avoiding the £30,000 annual fee.
Each year the investor can also bring 5 per cent of their gains into the UK tax free.
At the time of encashment, the profit will be subject to income tax if brought into the UK. But, say wealth managers, if non-domiciled investors encash the money in a jurisdiction which does not carry the same tax rates as the UK, they can save themselves this charge as well.
Using insurance bonds for this purpose is, says Karina Challon, director of the Specialist Tax Group at HSBC Private Bank, not for the mega wealthy, but for those to whom a £30,000 annual bill would make a noticeable dent to their investment profits.
There are, she says, a variety of investment products coming out from insurance houses to feed the new appetite for offshore insurance bond investment.
“It’s not right for everyone,” she says, “but I think we will start to see non doms use these structures where before they didn’t.” She identifies investors who are happy to leave their investments to grow without needing access to it as particularly likely to benefit from this investment structure.
