Not only does RDR eliminate the taint of so-called commission bias in the sale of insurance bonds, it restricts the use of enhanced allocation rates, often criticised as potentially mis-leading to clients. The removal of both these elements, which in many ways has detracted attention from the wrapper’s tax efficiencies, will strip it down to its basic tax advantages. Considering today’s low interest rate environment, meaning a high number of investors are seeking investment income, together with new tax thresholds being levied, finding efficient ways to shelter income will likely be a popular area for advisers in the near term.
The cleanliness of structure post-RDR means there will be no reason for an adviser to favour a particular product over another, which has often been the accusation levied against the advisory community, particularly with regards to insurance bonds.
Over time, the high commissions available on investment bonds have led to a stark polarisation of sales. There are some advisers who use them almost exclusively over other products and those that prefer to avoid them in case it appears they are chasing commission, which can be as high as between 8 and 9 per cent.
The market falls during the credit crisis, changes to capital gains tax in 2008 and the increased implication of so-called commission-bias has led to a dramatic fall in the popularity of investment bonds since 2007. Sales of the wrappers fell by some 75 per cent between their zenith in 2007 and 2009. Paul Kennedy, director of taxation and trust planning at Fidelity, does not believe the wrapper will ever again see its popularity rise to its 2007 heights but he agrees that RDR and other tax changes will offer some support. Sales appear to have stabilised through 2009 and may now be trending upwards again.
Margaret Jago, manager, investment products tax and regulation at Aegon Scottish Equitable, says the group has already noticed a surge in interest in offshore bond wrappers over the past six months. In addition, she says many of the bond investments are headed towards investment funds as opposed to cash accounts, which have been a popular underlying investment in offshore bonds in the past 18 months.
Jago points out that ahead of RDR, the structure of offshore bonds has changed with factory-gate pricing being implemented to accommodate fee-based IFAs. The offshore bond products seem to have moved faster to adapt than their onshore counterparts as the offshore products have long been accustomed to accommodating fee-based advisers.
She adds that recent tax changes highlight just how useful investment bonds can be, particularly for high net-worth individuals. Changes to the tax-free personal allowance from April mean those earning more than £100,000 a year will lose £1 of their allowance for every £2 of adjusted net income above that £100,000. By the time they reach £112,950, they will have no personal allowance left. People in this situation can attempt to reduce their income via pension contributions but they must be wary of any investment income that could lift them above the threshold, which is where investment bonds can play a role.
The same can be said for those on the verge of pushing beyond the new tax band of £150,000. The life wrapper has long been considered an efficient way in which to shelter income or interest-producing assets, such as fixed interest. Its facility allowing for 5 per cent withdrawals on a tax-deferred basis is another attractive feature that is often overlooked or outweighed by the perceived negative attributes of insurance bonds, such as their changing structure.
Kennedy notes wrappers all have different virtues that, post-RDR, will become easier to identify and compare. While there is no saying if life bonds will have charges on the same level as collectives or Isas, a structure not complicated by 100 per cent plus allocation rates will at least better allow like-for-like comparisons on tax benefits. Kenney says: “To any extent of an individual bias towards one wrapper over another, RDR ought to start knocking that down.”
The history of investment bond sales has not covered the product in glory, despite its useful features. More than a decade ago, sales in the products were in many ways ruled by their underlying investment choices, Kennedy says. Advisers often chose investment bonds when they wanted access to an insurance fund, that is, with-profits, while those seeking collectives like Oeics, went down the Pep route.
With the prevalence of open architecture, that is no longer the case. With similar underlying funds on offer and charging differences being levelled, advisers will now be better able to focus on the intricacies of tax planning, he says. “Tax planning is as integral to investment advice as risk or diversification because it influences return to the client. For those wishing to stick to investment terms, look at tax planning as seeking tax alpha. Some tax wrappers simply work better with some assets – just like fund managers – only with tax, the legislation dictates the alpha.”
Although investors monitor performance in their funds, it does not necessarily correlate with what they will actually receive, due to the heavy impact tax can have in the investment structure chosen. Instead, clients must look at the fund performance minus any tax taken. For example, Kennedy notes that with the same fund as the underlying investment in an onshore bond, offshore bond and as a straight collective investment, the difference in returns to the client between the best and worst wrapper can be as high as and 80 per cent.
There have been many misconceptions surrounding insurance bonds in recent years. Today, we are seeing changes in pricing and greater weight given to their seemingly forgotten tax benefits. Post-RDR, it will be interesting to see what happens to investment bond sales and whether or not this product is really as dead as some commentators were saying just a year ago.