Onshore investment bonds enjoy the following taxation advantages:
- Income paid out by the bond is deemed by HM Revenue & Customs to be net of basic rate income tax- hence the basic rate tax payer has no further tax to pay.
- Higher rate tax payers can apply “top slicing relief” to mitigate tax when they trigger a “chargeable gain”.
- Capital growth is taxed as income and the payment of this tax is deferred until partial or complete surrender.
- The funds held within the bond benefit from being free from capital gains tax, provided you are the owner of the investment bond.
- Investment bonds can be segmented, presenting additional tax planning options upon full or partial surrender which may be more advantageous than applying “top slicing relief”.
Investment bonds are often favoured by those seeking to generate an income, either now or at some point in the future. This is because it is possible to receive a regular income by taking withdrawals of up to 5% of the initial investment amount (for the first 20 years, or until the original capital invested is returned if withdrawals of less than 5% per annum are taken), tax deferred. This 5% per annum allowance of the original capital invested is cumulative- so if not used in one year can be carried forward to the next. Hence if you did not use your 5% allowance for the first three years of being invested, in the fourth year you could carry the unused three years forward and add it to the fourth year’s allowance, meaning 20% can be withdrawn with no immediate liability to income tax.
A key taxation benefit of investment bonds is that cumulative withdrawals of up to 5% per annum of the original sum invested are disregarded when calculating income which would reduce a person’s age-related allowances. This gives bonds an important advantage when compared to other sources of income.
If the value of the withdrawals you receive exceeds 5% (cumulative) of the original investment amount, a “chargeable event” is said to have occurred. Chargeable events can also be triggered by death or assignment for money’s worth. If you exceed your cumulative 5% withdrawals and trigger a chargeable event, you will be taxed at your highest marginal rate of income tax on the amount above 5%, but this is mitigated by applying a process called “top slicing“. If you are a higher rate taxpayer, you would be taxed at 40%, less the basic rate of tax on savings deemed to have been paid already at 20%. If you are an additional tax payer, you would be taxed at 45%, less 20%.
Onshore investment bonds are not considered suitable for non-taxpayers or for starting rate taxpayers (ie those paying income tax at 10%) since they are unable to reclaim the basic rate tax deducted from the bond. However, if the non or starting rate taxpayer is married to a higher rate bondholder, assigning the bond can create a valuable tax planning opportunity.
To find out how investment bonds can be used as part of wider tax planning, see our Using investment bonds for tax planning section.