Budget 2008: six point case for investment bonds
The Budget confirmed the changes to capital gains tax (CGT) for mutual funds announced in the pre-Budget report.
The changes announced see the introduction of a flat rate of 18% tax on capital gains, with the removal of indexation allowance and taper relief.
"There are winners and losers to the CGT changes," says Tim Rees, head of financial planning at Clerical Medical. "In the mutual funds versus investment bonds debate we believe when the tax efficiency, relative product costs and administrative simplicity are compared, financial advisers will continue to recommend investment bonds."
The six point case for investment bonds:
1. Control of the tax point
In a bond no personal tax is paid until a 'chargeable event' occurs, for example, cashing in the investment bond, which can be extremely useful for an investor who is a higher rate taxpayer when they invest, but likely to become a basic rate taxpayer later, for example in retirement. If an onshore bond is cashed in when the investor is a basic rate taxpayer they will have no further tax to pay on the income and gains.
2. Defer higher rate tax on income
The tax rates on income received by a fund for bonds and OEICs are broadly neutral. However, higher rate taxpayers investing in bonds have the considerable advantage in that they can defer the higher rate tax on their investment until a chosen time in the future. An investor in an OEIC must pay the higher rate tax on any income whether it is accumulated or not.
3. Switch funds without triggering a tax charge for the investor
A bond allows the investor to switch between funds without triggering a personal tax charge. In an OEIC this will usually be a disposal for CGT purposes.
4. Give bonds away without a tax charge
Bonds can be given away without triggering a tax charge. With an OEIC this would normally be a disposal for CGT purposes, although transfers between spouses and civil partners would not trigger a CGT liability. This can be particularly useful for making gifts into trust as part of inheritance tax planning, and for parents investing for university funding.
5. Bonds as trustee investments
Bonds can be very convenient for trustee investments. They are classed as non-income producing assets and so for many trusts, they can save a great deal of trustee administration and costs.
6. 5% annual withdrawal – deferring the tax charge
Bonds allow up to 5% a year to be withdrawn without triggering a tax charge. This allowance is cumulative so if no withdrawals are made in year 1, 10% can be withdrawn in year 2. The allowance continues until all of the original investment has been withdrawn.
That's not all! For the rest of our Budget 2008 coverage, click here
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Issued by life companies and designed to produce medium- to long-term capital growth, but can also be used to pay income. The minimum investment is typically £5,000 or £10,000 and your money is invested in the life company’s investment funds, so the bond can either be unit-linked or with-profits. They offer a number of tax advantages, such as the ability to withdraw up to 5% of the original investment amount each year without any immediate income tax liability. Also, a number of charges and fees apply, such as allocation rates, initial charges, annual charges and cash-in charges. As investment bonds are technically single-premium life insurance policies, they also include a small amount of life assurance and, on death, will pay out slightly more than the value of the fund.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.