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With equity markets falling, cautious investors might want to consider putting money into Guaranteed Income Bonds. These bonds, also known as GIBs, are an example of a product making a comeback as the markets turn downward. In the 1990s, they were havens for lump sum investments, paying reasonable rates of interest and guaranteeing the original money back. When the bull market came, investors lost interest in them. But now they are attracting attention again.
How do GIBs work?
Guaranteed Income bonds are quite similar to the run-of-the-mill fixed-rate savings bonds offered by banks and building societies in that they guarantee a fixed return in exchange for a one-off lump sum investment. At the end of the term your original lump sum is repaid. However, there is a difference in how they are taxed and in this way, they can be slightly more advantageous.
So how are they taxed?
The underlying funds within the investment are deemed to have been already taxed. This means that as long as the investor is still a basic rate taxpayer when the investment matures, there is no further tax to pay on the income received. However complicated “top-slicing” rules apply which could mean that even basic rate taxpayers have to pay tax.
Under top-slicing, any tax is deferred until the time that the bond matures when a top-slicing calculation is carried out to establish what, if any, additional tax is owed.
However, the bonds can be rolled over at maturity into other fixed terms, deferring liability further. They can also be assigned to other adults without a tax charge, with the higher rate tax liability being eliminated if the new owner is a non or standard rate taxpayer.
You can also withdraw an income of up to 5 per cent annually of the initial lump sum without incurring an immediate tax liability. This also applies to higher rate taxpayers.
Say, you invest £10,000 in a five-year GIB paying 4 per cent annual income. No tax will be payable when the income is received as it is below the 5 per cent hurdle. At maturity the top-slice calculation will be as follows: five payments of £400 divided by five years = a £400 “slice”. If the investor remains a basic rate taxpayer even after this is added to income, then there is no further tax to pay. A higher rate taxpayer would have to pay a further £80 (20 per cent x £400)
Who should consider buying a GIB?
Only invest in a GIB if you’re sure you won’t need the money until the bond matures. If you cash in a GIB before maturity, you could get back less than your original investment. GIBs are not a good idea for someone who is a basic rate taxpayer now but could be a higher-rate taxpayer at maturity. But someone who is a higher-rate taxpayer now and likely to be a basic rate one later on could benefit as payment is deferred until the end of the term.
How much can I invest?
The minimum investment is £5,000 and there is no maximum. Investment terms vary from one to five years.
Are there any other perks?
GIBs also offer some life insurance to cover the value of your investment. So, if you die while owning a GIB, your heirs can opt to receive either 101 per cent of the current value of the GIB or 100 per cent of your original investment minus any income paid by the insurer. Also, in contrast to investments with banks and building societies, your investment is protected even if the insurer that sold you the GIB collapses. In such a scenario, you would receive the first £2,000 in full and at least 90 per cent of the remainder of your investment, with no upper limit.
What about charges?
The charges to cover administration and other costs are factored into GIBs already, so you receive the rate of return the insurer advertises on the product. Commission paid to advisers who sell GIBs is relatively low – from 0.25 per cent for products with one-year terms to 1.5 per cent over five years.
How is income paid out?
The bonds can be quite flexible and income can be often be paid monthly, annually or when the bond matures.
What are the current rates on GIBs?
Cardiff Pinnacle offers a one-year GIB with a rate of 3.45 per cent. It requires a minimum investment of £10,000. AIG Life offers a three-year GIB at a rate of 3.85 per cent. It also offers a five-year GIB at a rate of 3.95 per cent. Abbey has a four-year product with a rate of 4.08 per cent. It requires a minimum investment of £5,000.
In most cases, the longer the lock-in period or the bigger the sum invested, the higher the interest that can be received. However, in periods when markets expect interest rates to fall, interest paid on GIBs can be lower.