Guide to investment bonds

An investment bond gives you the potential for medium to long-term growth on your money, money, so over 5-10 years or more, along with fund management expertise. You also get access to a mixture of funds, which are looked after by professional investment managers. Of course like any investment, their value can go down as well as up and you may not get back what you put in.

Investment bonds are usually classed as a single premium ‘life insurance’ policy because a portion of your ‘life insurance’ policy can be paid out upon death, but they are really an investment product. So if your need is solely for life insurance, you may wish to research other more tailored options. 

That said, you usually buy an investment bond from a life insurance company, or directly through a financial adviser. They will invest your premium on your behalf for potential capital growth, which should build up until you withdraw money from your policy.

You can withdraw up to 5% per year of the amount invested without paying any immediate tax.

Some investment bonds may require a minimum investment term and apply charges for cashing in early. There may also be a minimum investment amount that may range typically between £5,000 and £10,000.

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 your provider, 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 include fixed-rate bonds, corporate bonds and government 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 that you are treated as having paid Income Tax at the basic rate on the amount of your gain. This notional tax is not repayable in any circumstances. 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:

  • Death giving rise to benefits.
  • Transfers of legal ownership of part or all of the bond (though not gifts).
  • On the maturity of the bond (not applicable for whole of life policies).
  • You cash in all your bond or individual policies within it.
  • You withdraw more than the 5% a year tax-deferred allowance. See the section below on Taking withdrawals from the bond.

If any of the gain falls in the higher rate tax band you may get a reduction in your tax through top slicing relief, depending on your circumstances. This can be quite complicated, so to understand how this works please speak to your financial adviser.

As you are treated as having paid basic rate tax on the amount of the gain, the amount you would be liable for is the difference between the basic rate and higher or additional rate tax. The events may also affect your eligibility for certain tax credits and you could lose some or all of your entitlement to personal allowances. 

If you are 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.

Life assurance bonds held by UK corporate bonds fall under different legislation.

Special rules apply to trustee held bonds.

Offshore investment bonds

Offshore is a common term that is used to describe a range of locations where companies could offer customers growth on their funds that is largely free from tax. This includes "true offshore" locations such as the Channel Islands and 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 bonds may offer a wider choice of funds. 

Offshore investment bonds are similar to UK investment bonds, 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 by the underlying investment, whereas with an offshore bond no income or Capital Gains Tax is payable on the underlying investment. However, there may be an element of Withholding Tax that cannot be recovered. Withholding Tax is deducted from interest and dividends received by the fund.

The lack of tax on an offshore bond means that potentially it could grow faster than one that is onshore, although this isn't guaranteed. 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 are not treated as having paid basic rate tax on any gain. The events may also affect your eligibility for certain tax credits and you could lose some or all of your entitlement to personal allowances.

Other common types of bonds include fixed-rate bonds, corporate bonds and government bonds. Each have their own benefits and risks and the tax situation of each can vary.

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).

However, if you decide to take more than 5% per year and/or you cash in your entire bond, your insurance company or financial adviser will calculate any gains on your money, 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. However, unless you’ve opted for a guarantee, which some investment bonds offer at an extra cost, there is still the potential that you may not get back the amount you invested.

To find out about the fund choices available on our investment bonds, see the investment products section.

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 the website and on our Tax and Allowances webpage.

Remember that the value of an investment can go down as well as up and you may not get back the amount you put in.

We are not recommending one option over another or providing advice.

Because tax rules can change, the impact of taxation (and any tax relief) depends on your individual circumstances. 

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