Using an investment wrapper set up by a life insurance company in a jurisdiction with a favourable tax regime, such as the Isle of Man or Dublin, opens up a wealth of planning opportunities.
Investors benefit from growth that is largely free of tax as no tax is imposed on the income and gains in the underlying funds – this is known as 'gross roll-up'. Growth may not be entirely tax free, however, due to the impact of irrecoverable withholding tax that may be deducted from interest and dividends received by the fund.
Each year an individual may be entitled to a personal allowance, starting rate for savings income and the personal savings allowance. But to get the most of the tax-free allowances requires careful planning and timing. This is where the unique features of an international bond can aid tax planning.
The first thing to remember is a client can withdraw 5 per cent of the total amount invested each year without an immediate liability to income tax. This is known as the ‘tax-deferred withdrawal’ facility. Where the facility is not used in one year it can be carried over to the next year. So, someone with £300,000 to invest could take, for example, £15,000 each year for a period of 20 years, or £12,000 (4 per cent) for a period of 25 years.
By splitting the bond into a number of ‘segments’ the client has the flexibility to fully encash segments rather than take a withdrawal across the whole bond.
Remember, if a gain is realised from an international bond it is treated as ‘savings income’ so, together with the personal allowance, the starting rate for savings allowance and the personal savings allowance, an international bond offers tax-efficient planning.
This means that a non-taxpayer can realise up to £17,000 of gains without any personal liability to tax. This is made up of their personal allowance (£11,000 for 2016/17) and then the ‘starting rate for savings’ (£5,000), which is taxed at 0 per cent. On top of that there is the personal savings allowance (£1,000 for 2016/17) although this is reduced to £500 for higher-rate taxpayers. Additional-rate taxpayers do not benefit from the personal savings allowance.
For basic-rate and higher-rate taxpayers top-slicing is an important tool that can be used where the total gain would take the client into the higher-rate or additional-rate tax brackets. Top-slicing allows the gain to be proportioned over the number of complete years the bond has been in force. Remember, when dealing with international bonds top-slicing is always back to inception, irrespective of whether there have been previous chargeable events.
Assigning the bond or individual segments will shift the taxation onto the new policy owner. This can be a valuable planning opportunity especially if the new owner may be a non-taxpayer.
The fact that bonds can be assigned without a tax charge means owners that pay higher rates of tax could assign to a spouse or child who has little or no income to fulfil distributive functions in a tax-efficient manner. In effect, tax responsibility is passed to the recipient, minimising administrative costs and ensuring an even-handedness of treatment.
It can be a great way to help with a child’s or grandchild’s university fees. Bond segments can be assigned to the student, who is likely to be a non-taxpayer if they’re in full-time education. Provided gains are kept within the £17,000 allowance, they won’t be taxed. Over a three-year course, that’s up to £51,000 in chargeable gains that can be taken free of tax.
If you are a UK resident planning on moving abroad, an international bond can offer you an opportunity to pay less tax because you will be taxed according to the local jurisdiction of the country you are moving to. If this offers a lower tax regime than the UK, you could pay less tax. You always have the option of surrendering your international bond before you leave for an overseas destination if the local tax regime is higher than in the UK.
An international bond can be a useful pension alternative for providing additional retirement funds. A mix of pensions and bonds close to and at retirement can complement each other. As the bond has no age restrictions on withdrawals, it is possible to take tax-efficient payments (within the 5 per cent limit) before, say, the age of 55, to act as a bridging income until retirement or to supplement reduced wages. Then, once the pension becomes available, it is possible to phase income payments so that only the tax-free cash is used, providing additional tax-free income.
- An international bond offers a simple and straightforward, tax-efficient investment solution.
- Timing these chargeable events to coincide with a year in which little or no other income is taken can mean that any gains escape tax completely.
- For any client who wishes to fund school fees/university costs or supplement pension income, an international bond is a very flexible wrapper.
- They can be useful for clients who may move abroad or retire abroad because they can be portable.