Investment Bond

In UK finance there are two main ways to buy investments: via an asset or fund management house or through a life company. The difference is the product wrapper that surrounds the underlying investment and the tax treatment of that investment as a result. An investment bond can only be offered by a life company and, like an ISA, is basically a wrapper around your investment that gives certain benefits.

Investment bonds are generally available for single premiums - i.e. a one-off, lump sum. You can choose how that money is invested from a range of options - and traditionally, the most popular have been with-profits, managed and distribution funds, combining a variety of asset classes within one fund. However, today, the range of options is much greater, with both diverse and specialist funds being offered through external links to fund management houses.

Funds within an investment bond pay tax equivalent to the basic rate and there is no specific benefit to help investors save tax. However, for higher rate tax payers, it does offer the chance to defer their liability to additional tax. Under the deferral rules, you can withdraw up to 5% of your initial investment each year without becoming immediately liable for tax on it. This amount can be withdrawn every year for up to 20 years - up to a maximum 100% of your initial investment. It is not until you then cash in the entire investment bond that you are assessed for any additional tax on your gains.

This postponement of the tax liability can be particularly advantageous if you are a higher rate taxpayer now but expect to become a basic rate taxpayer in future, perhaps after retirement. The tax charge applies at the rate you are paying when the bond is encashed, not when the income was taken. As the bond has already been paying the equivalent of basic rate tax during its term, in this example, you would end up owing nothing more.

The structure of investment bonds means they can also offer facilities which many mutual funds cannot. Phased switching, to and from cash funds, for example, can help you dip into or out of a more volatile fund. Regular withdrawal facilities let you take a fixed income. And, as life assurance products, they also carry life cover - ranging between 100.1 and 101% of the original capital. As the underlying value can fall as well as rise, this can help secure your investment should the worst happen.

However, investment bonds can be a less tax efficient method of investing. Broadly speaking, your growth and income from the underlying investments is taxed each year, whereas, investing within mutual funds (OEICS and Unit Trusts), your income is taxed but your capital gains are not taxed until they are realised. Bearing in mind that you have a capital gains tax allowance, it is possible to save a significant amount of tax using mutual funds rather than investment bonds.

As a firm we favour unit trust funds, but we also understand exactly when and where an investment bond may well be suitable. Our recommendations will always take account of the full product range available.