Tax rules can change and the impact of taxation and any tax relief depends on your circ*mstances, includingwhere you live.
Types of investment bonds
Investment bonds mainly fall into two categories, onshore and offshore. The main difference is their tax treatment. In high-level terms, those onshore are subject to UK corporation tax, which is offset by yourprovider, while offshore bonds are issued from outside the UK and the returns roll up gross of tax in the funds, apart from Withholding Tax, as described below.Offshore bonds may also offer a wider choice of funds.
Other common types of bonds includefixed-rate bonds,corporate bondsandgovernment bonds. Each have their own benefits and risks and the tax situation of each can vary.
Onshore investment bonds
UK Investment Bonds are non-income producing investments and so have a different tax treatment from other UK based investments. This can provide valuable tax planning opportunities for individuals.
The funds underlying the bond are subject to UK life fund taxation meaning thatyou're treated as having paid IncomeTax at the basic rate on the amount of your gain. This notional tax is not repayable in any circ*mstances. You will have no liability to Capital Gains Tax or basic rate Income Tax on bond gains.
Certain events, also known as chargeable events, that can occur during the lifetime of your onshore investment bond may trigger a potential Income Tax liability:
You can withdraw up to 5% each year of the amount you have paid into your bond without paying any immediate tax on it, more information on thishere.
As you're treated as having paid basic rate tax on the amount of the gain, the maximum rate you would be liable for is the difference between the basic rate andyour highest rate of income tax for the relevant tax year. The gains may also affect your eligibility for certain tax credits and you could lose some or all of your entitlement to personal allowances.
If you're a higher or additional rate taxpayer now but know that you will become a basic rate taxpayer later (perhaps when you retire for example) then you might consider deferring any withdrawals from the bond (in excess of the accumulated 5% allowances) until that time. If you do this, you may not need to pay tax on any gains from your bond.
Special rules apply to trustee held bonds.
Offshore investment bonds
Offshoreis a common term that's used to describe a range of locations where companies could offer customers growth on their funds that's largely free from tax. This includes "true offshore" locations such as the Channel Islands and the Isle of Man, and other locations such as Dublin. Tax treatment can vary from one type of investment to another, and from one market location to another.
Offshore investment bonds are similar to UK investmentbonds, as chargeable events occur on the same events described above for onshore bonds but there is one main difference. With an onshore bond, tax is payable on gains made (and investment income received) from the underlying investments of the life fund(s) invested in, whereas with an offshore bond no income or Capital Gains Tax is payable on the underlyinglife fund investments. However, there may be an element of Withholding Tax that can't be recovered. Withholding Tax is deducted from interest and dividends received by the fund(s).
The lack of tax on an offshore bond means that potentially it could grow faster than one that is onshore, although this isn'tguaranteed and the effect of other factors, such as charges, need to be taken into account in any comparisons. But, note that you will pay income tax on any gain at your highest marginal tax rate. This is because on an offshore bond you're not treated as having paid basic rate tax on any gain.The gains may also affect your eligibility for certain tax credits and you could lose some or all of your entitlement to personal allowances.
Top slicing relief for gains on Onshore and Offshore bonds
Top slicing relief can assist in reducing the rate of tax charged on bond gains by applying a spreading mechanism and is generally available where at least part of your income would be liable to a higher tax rate once you include a gain. If a gain doesn’t move you into a higher tax rate, there may still be some top slicing relief available due to the effect of the personal savings allowance nil rate and the starting rate for savings.
If top slicing relief applies, youmay get a reduction on the tax payable on a chargeable event gain. HMRC have a process for calculating this which can be very complex, so if you would like to understand how this works, please speak to your financial adviser.
Taking withdrawals from the bond
An investment bond could therefore be a potentially tax-efficient way of holding a range of investment funds in one place.
You can withdraw up to 5% each year of the amount you have paid into your bond without paying any immediate tax on it. This allowance is cumulative so any unused part of this 5% limit can be carried forward to future years (although the total cannot be greater than 100% of the amount paid in). You will often see this referred to as the "5% tax-deferred allowance".
However, if you decide to take more than the accumulated 5% tax-deferred allowance, you will create a gain equal to the amount taken over the allowance. Your insurance company will send you details of the chargeable event gain arising for you to notify HMRC of the gain, and, you may be subject to Income Tax.
Fund choice
When you invest in a bond you will be allocated a certain number of units in the funds of your choice or those set out by the conditions of the bond. You can choose to invest in a range of funds, a portfolio, or a mixture of both. You can also usually switch between funds within your bond. However, there may be a charge for this.
Each fund will invest in a range of assets, such as fixed interest, shares and property,and the price of your units will normally rise and fall in line with the value of these assets. If invested in a diverse range of assets then there is potential to weather the storm of any changes in the market that could affect the value of your investment.
To find out about the fund choices available on our investment bonds, see theinvestment productssection.
Further information
If you need more information on bonds, please speak to a tax specialist or contact a financial adviser. Information is also available on thegov.ukwebsiteand on ourTax and Allowanceswebpage.
If you are looking to take out an investment bond advice must be sought. If you don’t have an adviser, please visit mandg.com/pru/customer/en-gb/financial-advice/find-adviser to find one, or you can find an independent financial adviser at unbiased.co.uk
We are not recommending one option over another or providing advice.
