In today's climate of stockmarket uncertainty and low interest rates, many financial advisers and investors are wondering where they can invest to achieve competitive, low-risk, low-volatility returns. Traded endowment policies offer just that.
The last few months have seen a tremendous surge of interest in Teps. The appeal of this type of investment is that competitive returns can be achieved in the medium term and risk is low because much of the investment is guaranteed by the bonus structure. This safeguards against the horrific market downturns that many have experienced recently.
With distinctive tax advantages, Teps are an important alternative to more volatile equity-based Isas. Regardless of whether investors are higheror basic-rate taxpayers, it is possible, with a little planning, to generate returns that are not liable for any personal taxation.
Investors are starting to appreciate just how tax-efficient Teps can be. Indeed, many financial advisers are recommending the benefits of Teps for a whole range of investment objectives, including:
School fees planning.
Saving for the future.
Investment in Sipps and small self-administered schemes.
Investment by expatriates and overseas investors.
Reducing capital gains tax liabilities.
Teps fall into two categories – qualifying and non-qualifying policies. Qualifying policies are those that have been in force for at least 10 years. They only have a potential liability for CGT. The taxable gain for CGT purposes is defined as the difference between the policy proceeds on disposal and the total investment since purchase, that is, the initial investment plus all subsequent premiums.
Non-qualifying policies are those that have been in force for less than 10 years or less than three-quarters of the original term if gains are realised sooner. These gains have a potential liability for both income tax and CGT.
In calculating the income tax liability for a non-qualifying policy, the taxable gain is simply the difference between the policy proceeds on disposal and the total premiums paid under the policy.
By utilising the investor's annual CGT allowance, the gains from a qualifying policy can be sheltered. As the annual allowance is £7,500 for 2001/02, this could allow a significant tax-free investment. In fact, the annual allowance is £500 a year more than the current individual Isa allowance but many people do not use it.
The liability for CGT can be further reduced through the use of taper relief if the policy has been held for at least three years. When using taper relief, the amount of the gain chargeable to CGT is reduced on a sliding scale by up to 40 per cent after 10 years of ownership.
As Teps have no restriction on the number of owners of the policy, more than one person's CGT allowance can be used, hence sheltering more gains.
But the gains realised from a non-qualifying policy could be subject to income tax if the gain takes the investor into the higher-rate tax band. There may also be a liability for CGT on the gain. To avoid double-charging, the amount chargeable as income is excluded from the amount chargeable to CGT. The use of annual allowances and taper relief can reduce further any CGT liability.
Higher-rate taxpayers tend to consider qualifying policies while, for basic-rate taxpayers, either type of Tep can be a tax-efficient investment.
With compelling tax opportunities and low risk levels, Teps have the potential to play a part in every investor's portfolio. So far, they have remained a reasonably well kept secret.