Wrappers Unwrapped 2: Investment Funds vs Insurance Bonds

Investment Funds (OEICs, unit trusts)	Insurance Bonds (Onshore and Offshore)
Gives exposure to a pooled, professionally-managed investment portfolio	Gives exposure to a pooled, professionally-managed investment portfolio
Wide range of strategies available	Wide range of strategies available
No life insurance element	Includes a life insurance element
Can be held in an ISA or SIPP	Cannot be held in an ISA  or SIPP – but offshore versions are available
Can be held indefinitely and redeemed at any time	May have a minimum term

Some of the tax benefits of investment funds

• If a client has their capital gains ‘Annual Exempt Allowance’ to use up, gains from investment funds can be set against it. Gains on insurance bonds can’t.
• If a client hasn’t used up their Starting Rate for Savings/Personal Savings Allowance, some/all of the interest on an interest-distributing fund may be tax free.
• If a client hasn’t used up their annual dividend allowance, up to the first £2,000 a year from a dividend-distributing investment fund may be tax free.
• Some of the tax benefits of insurance bonds
• If an income-seeking client has used up their personal and ISA allowances, the 5%pa ‘tax-deferred’ allowance on insurance bonds can help generate a tax-efficient income.
• If a client hasn’t used up their Starting Rate for Savings/Personal Savings Allowance, some/all of gains realised on an offshore bond may be tax free.
• If a client wishes to pass on wealth, heirs can be included on investment bonds as ‘lives assured’, allowing bonds to be inherited on death without a taxable ‘chargeable event’.
• If a higher or additional tax-rate payer expects to become a basic-rate taxpayer at a later date, the ability to defer withdrawals on an insurance bond may be beneficial.

Investment Funds (OEICs, unit trusts held outside of an ISA)

Internal tax treatment:

• Interest and rental income subject to corporation tax at 20%¹
• No corporation tax to pay on dividends or capital gains within the fund

External income tax treatment

Applies to both accumulation and income shares:

• On funds distributing dividends:
• Dividends now paid gross
• First £2,000 tax-free if dividend allowance available
• Thereafter taxed at basic (7.5%), higher (32.5%) or additional (38.1%) rates
• On funds distributing interest2:
• Interest now paid gross
• Starting Rate for Savings and Personal Savings Allowance allows some interest to be tax-free – will vary with holder’s tax rate/income
• Interest then taxed at basic (20%), higher (40%) and additional (45%) rates

External capital gains treatment

• Sales and disposals of shares subject to capital gains tax (CGT), with gains calculated on an average cost basis.
• Switches between share classes in same fund not treated as a disposal for CGT
• Tax only payable if gains exceed the Annual Exempt Amount of £12,300
• Gains then taxed at the basic (20%) or higher (40%) rate

Tax treatment on death

• Investment funds included in an estate for inheritance tax purposes unless held in certain trust arrangements

Insurance Bonds (Onshore and Offshore)

Internal tax treatment

Onshore bonds: Same as investment funds (left) plus 20% corporation tax also payable on realised capital gains

Offshore bonds: Usually registered in a tax-favoured jurisdiction, enabling  ‘gross roll-up’ of gains and income³

External income tax treatment

Gains on bonds only subject to tax on the following ‘chargeable events

• Full surrender of the bond
• Part-surrenders in excess of 5%pa of the original premium
• Transfer of legal ownership in return for money/money’s worth
• Maturity of a capital redemption bond
• Death of the last life assured

Rates of tax charged

Onshore bonds: Gains treated as the highest slice of income and the tax rate will depends on the marginal rate they push the holder into: basic (0%⁴), higher (20%) and additional rate (25%)

Offshore bonds:  Gains treated as savings income and can be set against the Personal Allowance, Savings Starting Rate and/or Personal Savings Allowance where available. Then taxed at basic (20%), higher (40%) or additional rate (45%)

External capital gains treatment

Profits on insurance bonds are not subject to capital gains tax – only income tax, as above.

Tax treatment on death

• Gains taxed as above only on death of last life assured.
• Capital redemption bonds can be passed on without a chargeable event

Notes:

1 - To avoid double taxation, if a fund is interest-distributing, gross interest distributions are relievable as an  expense against the fund’s income 2 - To qualify, 60% of more of the fund’s market value must be invested in interest-yielding assets – e.g fixed-interest bonds and cash deposits 3 - Withholding tax may be deducted at source and cannot be reclaimed 4 - Reflects that corporation tax is paid internally