Since the introduction of the RDR and with the increasing amount of business done on platform where, understandably, for non-Isa or non-Sipp/pensions-related investments the “default” strategy is one of unwrapped investments, it seems that (with a few notable reported exceptions) investment bonds, and particularly UK investment bonds, have attracted less adviser and investor attention.
The exception, anecdotally at least, appears to be where there is a need for a trust. In this case, the predominant wrapper appears to be an investment bond. Now some of that will be down to habit and some down to the fact, of course, that the bond is more suitable (and in some cases exclusively so) as a trustee investment.
However, it is worth noting that the advent of platforms has driven a substantial expansion of trusts that can be used with either insurance bonds or collectives. The use of trusts with other than insurance products is a theme I will return to in later articles.
For the moment, though, I will return to the RDR and its impact, or otherwise, on the suitability of UK bonds as an investment. Of course, commission payments for new business have stopped and there can be some challenges to consider in relation to funding adviser charges from the products. But it seems to me that, apart from these aspects, the qualities of the UK bond as a tax wrapper remain as valid or invalid (dependent on the circumstances) as they were before the RDR.
That is not to say that everyone should have a UK bond wrapped around their portfolio. It is not to say, either, that everybody could have a UK bond wrapped around their portfolio. In a world where open architecture and access to DFMs and model portfolios is prevalent, the comparatively restricted access to funds in some UK bonds may rule them out on suitability grounds regardless of their tax attractions at fund or investor level. And then there are charges to consider.
However, if all of these boxes (that is, access to portfolios that are suitable for the investor and charges that are also neutral/acceptable) are ticked then, RDR or no RDR, the tax qualities of the UK bond for certain portfolios and certain investors is worth considering. And that’s without considering any trust-planning aspects.
As I mentioned earlier, the insurance bond still appears to be the investment wrapper of choice if trust planning is contemplated. With a few exceptions the bond will be the only way to carry out planning through a discounted gift trust.
What follows is a short revision session on the fundamentals of UK bond taxation.
First let’s look at fund level taxation. Remember the investments and the income and gains they produce are the property of the insurer. They carry no tax implications for the investor who only has to consider taxation when a chargeable event occurs. This quality of a UK bond should not be overlooked – simplicity is a very powerful benefit for many in an increasingly complicated life.
If we start with capital gains, the actual rate of tax on capital gains made in the UK life fund will rarely be the full 20 per cent of realised capital gains because the insurance company benefits from indexation allowance (based on the RPI as opposed to the CPI) in calculating taxable capital gains. Additionally, whilst the life fund will pay tax on an annual deemed realisation of underlying collective investments, this liability is effectively spread over seven years. All of this helps reduce the effective rate of tax reserved for in pricing the units representing the insurance bond investment. This is an actuarial function and with very few, if any, exceptions, this “effective underlying rate” is not made public.
This is interesting as it could represent a very important factor in the assessment of how the underlying investments are taxed in a UK life fund and thus the attraction of a UK investment bond as a wrapper for a particular portfolio. The fact that indexation allowance is available to life funds (as it is to all companies) is something that is not (it seems) readily appreciated but is something that has a real impact on the overall effective rate of tax borne inside the life fund.
Next week I will look at the taxation of income generated by the life fund and also investor taxation.
Tony Wickenden is joint managing director of Technical Connection
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