ONSHORE INVESTMENT BONDS FEATURES AND BENEFITS OF ONSHORE INVESTMENT BONDS. This is not a consumer advertisement. It is intended for professional financial advisers and should not be relied upon by private investors Legal & General select portfolio bond or any other persons.
2 ONSHORE INVESTMENT BONDS AND THEIR PLACE IN THE MARKET. BACKGROUND With an abundance of product choice available in the post-rdr investment marketplace, selecting the investment vehicle to get the right solution for your clients can be challenging. We believe onshore investment bonds are a particularly useful tool to satisfy the needs of investors looking for: growth on their investment over the medium to long term a range of income options including fixed levels of withdrawals pre/post retirement income provision with options to improve planning to minimise future tax liabilities and the flexibility to support changing needs a suitable investment vehicle for estate planning a range of funds available to help tailor a portfolio according to their attitude to risk and investment goals a straightforward yet flexible product for those who want an easy to manage investment (although the complexity of each product can vary between providers). However, onshore investment bonds aren t right for everyone, as we believe they are not typically suitable for potential investors that: are non-tax payers, unless other benefits such as estate planning or fixed income needs outweigh payment of the equivalent of basic rate tax within the bond haven t considered other investment types that may be more suitable to their needs, especially tax-favoured products such as ISAs and pensions aren t willing to accept any risk to their investment can t commit to a medium to long-term investment are not UK resident. Primarily, investment bonds are structured and taxed differently to other popular investment types, which can be beneficial to your clients in certain situations. This guide will first provide a reminder of the unique way investment bonds are taxed, then highlight how your clients could benefit from an investment bond s many features and benefits. We remain committed to the investment bond market and are fully RDR compliant, with products that include facilitated adviser charging. If you would like more information about our investment bonds please visit our Adviser Centre. The information in this document is correct as of 20 September 2017. The value of a bond, and any income taken from it, can fall as well as rise, and your clients may get back less than they invest. Although there is no fixed term, an investment bond should be considered a medium to long-term investment of at least five years, ideally longer. The information in this document is based on our understanding of tax law and HM Revenue & Customs practice, which may change.
3 HOW ARE ONSHORE INVESTMENT BONDS TAXED? Single premium investment bonds are taxed under the chargeable events tax regime. This means that investment growth realised may result in an income tax liability for your client, rather than being subject to capital gains tax (CGT) if invested in a unit trust or OEIC. An individual holding an investment bond will only be required to pay income tax if: a chargeable event occurs, and this results in a chargeable gain, and the chargeable gain (when added to all other taxable income) falls into the individual s higher or additional rate tax band. For onshore investment bonds, any liability to the basic rate of income tax is covered by the tax paid within the life funds that the bond invests in. CHARGEABLE EVENTS ON INVESTMENT BONDS A chargeable event on an investment bond can be any of the following: the death of a life assured resulting in death benefits being paid all or part of the bond is assigned to another individual for money or money s worth an amount in excess of the cumulative 5% annual allowances is taken a whole policy or segment within the bond is fully surrendered maturity, although most bonds are whole of life contracts where this will not apply.
4 STRUCTURE OF INVESTMENT BONDS Investment bonds are normally set up as a series of policies (or segments) to add flexibility when taking money from the bond. The number of policies will vary between providers, from 10 up to 10,000 or higher in some instances. The amount of the investment is then usually spread equally across each policy, so each one is identical. CALCULATING HOW MUCH TAX IS DUE There are two ways of taking money from an investment bond: partially cashing in all policies, or cashing in one or more whole individual policies. Each method will have different results for your client depending on their personal circumstances. Partially cashing in all policies When partially cashing in all policies, the chargeable gain is worked out as follows: Amount withdrawn = 5% annual allowances (rolled up if not used in previous policy years) Chargeable gain Cashing in whole policies When a whole policy is fully cashed in, the chargeable gain is worked out as follows: Final cash in value + = Value of all withdrawals Amount invested Previous chargeable gains Chargeable gain
5 TAX ON THE CHARGEABLE GAIN The amount of a chargeable gain is added to an individual s income to see what tax band this falls into and therefore how much tax is due, although this could still be within the basic rate tax band and therefore not liable for additional income tax. Please note these figures would be different for a Scottish taxpayer, as they have a lower higher rate tax threshold. EXAMPLE 1 Annabel has taxable income of 33,000 for the tax year 2017/2018. She cashes in her investment bond, which results in a 10,000 chargeable gain. Her taxable income and chargeable gain together equals 43,000, which is still within her basic rate tax band and therefore no further tax is due. EXAMPLE 2 Annabel has taxable income of 63,500 for the tax year 2017/2018. She cashes in her investment bond, which results in a 10,000 chargeable gain. Her taxable income and chargeable gain together equals 73,500, with the whole of the 10,000 chargeable gain falling into her higher rate tax band. As the basic rate tax liability has already been covered by the tax paid within the life funds, the higher rate tax liability on the chargeable gain is only 20% (that is 40% - 20% = 20%). Annabel s tax liability in respect of her chargeable gain is therefore 10,000 x 20% = 2,000. EXAMPLE 3 Annabel has taxable income of 44,385 for the tax year 2017/2018. She cashes in her investment bond, which results in a 10,000 chargeable gain. Her taxable income and chargeable gain together equals 54,385, with 9,385 of the chargeable gain falling into her higher rate tax band. Annabel s tax liability in respect of her chargeable gain is therefore 9,385 x 20% = 1,877. TOP SLICING Where the amount of the chargeable gain falls partly in one tax band and partly in another, as shown in example 3, the investor could benefit from the top slicing rules. This allows the chargeable gain on their bond to be divided by the number of complete policy years over which it has been accrued (or since any previous chargeable gain on that policy) so that only part of the chargeable gain, if any, then falls into the higher or additional rate tax bands. Let us assume that in example 3 the investment bond had been running for 10 complete years and there had been no previous chargeable gains. This means that Annabel can divide her gain of 10,000 over 10 years, which equals 1,000. We then add this top sliced gain to Annabel s taxable income to determine how much of the chargeable gain falls into her higher rate tax band and then multiply that by the 10 years to determine how much is taxable. Taxable income + top sliced chargeable gain = 44,385 + 1,000 = 45,385 Amount falling into higher rate tax band = 45,385-45,000 = 385 Amount subject to personal taxation = 385 x 10 years = 3,850 Tax payable on chargeable gain = 3,850 x 20% = 770 This is a saving of 1,107 when compared with the tax liability Annabel would have had if top slicing had not been used.
6 FEATURES AND BENEFITS OF AN INVESTMENT BOND. PERSONAL TAXATION The 5% annual allowance An investment bond allows your client to take withdrawals of up to 5% of the amount originally invested each year, for up to 20 years as a return of capital. This is known as the 5% annual allowance. Your client can take regular withdrawals to provide an income from their investment of up to 5% without paying any immediate tax or needing to declare this as income on a tax return. Alternatively, a lower level of withdrawals or none at all can be selected in the early years of investment and the allowance can be carried forward, so a higher percentage can be taken in later years. Clients can build up a cumulative allowance to take a higher income when needed, for example when reducing working hours or retiring. Allowances The regular withdrawals taken from an investment bond are considered return of capital rather than income. This means that your client can take annual withdrawals of up to the 5% annual allowance without reducing any of the following: Personal allowance Age related personal allowance Working Tax Credits Child Tax Credits Using regular withdrawals from an investment bond to provide an income rather than taking an income from some other types of investment could mean your client pays less tax and/or creates a smaller impact against their tax allowances/credits. Regular withdrawals and encashment are not counted towards your client s annual CGT exempt amount. The CGT annual exempt amount is unaffected.
7 Life fund taxation The provider of an investment bond pays corporation tax on the income and growth made within the funds. However, unlike personal CGT, indexation relief (measured by RPI) is available on any growth made within the funds. In periods of high inflation the amount of tax paid within the funds will be less than the basic rate of tax that an investor is deemed to have paid. Investment bonds are non-income producing assets, which means there is no personal income tax liability on any income produced within the funds. Income within a life fund is subject to corporation tax at a rate broadly equivalent to basic rate income tax only. There is no higher or additional income tax liability on the income reinvested within the life funds. A personal income tax liability can only arise on a chargeable gain. Switching between funds is usually free and does not give rise to a CGT or income tax liability. There are usually no charges when switching funds and no liability to tax. Your client has the freedom to manage portfolios without fear of incurring charges or tax liabilities. No forced encashment Most investment bonds do not have a maturity date, allowing the investor to decide when he or she wants to cash in their investment. Your client is not forced to cash in their bond at a particular point in time, giving them the freedom to choose when to cash in and therefore when any tax charge on a chargeable gain is due. The plan will only end prior to this if the death benefits become payable due to the death of a life assured (this is usually the death of the last life assured but for some bonds this can be on the first death). Most investment bonds also allow more than two lives assured to be named reducing the chance of the bond ending prematurely.
8 Choice when cashing in When cashing in, your clients can use their investment bond s flexibility to choose a method to best suit their circumstances. The amount can be taken from the bond by: cashing in one or more whole policies this is always a chargeable event. partially cashing in all policies a chargeable event is only triggered if the total amount withdrawn during a single policy year is more than 5% of the original investment. Although this may not necessarily result in a chargeable gain if previous years 5% annual allowance can be rolled over. When subsequently fully cashing in a whole policy and calculating the chargeable gain, any previous chargeable gains on that policy can be deducted (see Cashing in whole policies on page 4). a combination of both of the above this can help minimise any immediate tax liability by tailoring a withdrawal to your clients individual circumstances. It also allows a specific amount to be taken. Client scenario If your client is a basic rate tax payer now but expects to be a higher rate tax payer in the future. By fully cashing in one or more policies, tax is only due on the actual growth made on those policies, rather than on the excess chargeable gain (the amount over 5%) if taken partially from all policies. If your client is a higher or additional rate tax payer now but expects to pay tax at a lower rate in the future. By partially cashing in all policies up to the 5% annual allowance, your clients could defer any tax liability until they become a basic rate tax payer. If any liability occurs when they are a basic rate tax payer, it is covered by the tax paid on the life fund so there is no personal liability to income tax. If your client is a higher or additional rate tax payer now but expects to pay tax at a lower rate in the future, and they wish to take a withdrawal of more than 5% of their initial investment in the current policy year. By using a combination of cashing in individual policies and partially across the remaining policies, your client could reduce the amount of any higher/additional rate tax immediately due and increase the net amount they receive from the bond over the period it s in force. Care must be taken when deciding on the right method of cashing in. The method that best suits your client will depend on their personal circumstances both now and in the future, including whether they need to take regular withdrawals from the bond. ISA subscription limit Clients who regularly use their ISA subscription limit will often be looking for alternative investment products. Pensions Annual Allowance Clients who have used their Pensions Annual Allowance may be looking for alternative products to make further retirement planning provisions. An investment bond can be used to accumulate wealth and also to provide income at later stages in life by taking regular withdrawals. Unlike a pension there is no minimum age limit on when income can be taken.
9 INCOME PROVISION Your client can take regular withdrawals in a variety of different ways in order to provide them with an income. Regular withdrawal type Fixed A percentage each year of the amount invested or a fixed amount in pounds. Variable A percentage each year of the current value of the bond. This provides certainty of income and makes it easy to plan for monthly expenditure. If your client is in need of a fixed amount of income this can also be achieved with products that pay variable income by withdrawing additional capital. However, this can cause your client potential tax issues. For example, if this method is applied to a unit trust or OEIC then the encashment of units may eat into their CGT annual exempt amount or, worse still, give rise to a CGT charge. As these are based on the current value of the bond, the withdrawals will be larger if the value of the bond increases and will be smaller if the value of the bond decreases. Natural income Available on certain funds that pay out the income generated from the assets held within the fund, for example dividends, interest and rent. This provides a variable level of income. It allows the investment the potential to grow if there is an increase in the market values of the underlying investments (combined with any accumulated income that has not been distributed). Fund choice Investment bonds normally offer fund ranges that include a mix of: Index-tracking funds Actively managed funds Multi-asset funds Externally managed funds. The fund choice will generally cover a range of ABI sectors, regions, industries and markets. You can choose funds to suit your client s current attitude to risk and investment objectives. The choice gives your client the ability to adapt their bond to changes in their attitude to risk and investment objectives over time. Your client can invest in growth and/or income funds and still have the option to take a level of income that suits their personal circumstances.
10 ESTATE PLANNING A view frequently taken is that inheritance tax (IHT) is now no longer an issue due to the introduction of the transferable nil rate band and the additional main residence nil rate band. The truth is that for many clients, this will not be the case. With the nil rate band now frozen at 325,000 until April 2021, and the residence nil rate band only applicable to children or grandchildren, some individuals will still fall into the IHT net. In addition to those already described, investment bonds also offer features and benefits that make them especially useful as an investment vehicle for tax planning. Assignment and administration Each individual policy can be assigned separately, so one investment bond could be used to assign policies to many different individuals. For easy administration, trustees can use one bond to hold a trust fund for multiple beneficiaries. This can be very useful where gifts are to be made to several children or grandchildren. Unlike certain other investment products, assigning an investment bond as a gift to another individual will not trigger a chargeable event, nor is it a disposal for CGT purposes. There is no personal tax liability when assigning the bond to either trustees or beneficiaries (provided the assignment is not done for money or money's worth). Trustees of discretionary or flexible power of appointment trusts will only be required to declare investment bond growth on an annual tax return if a chargeable event occurs resulting in a chargeable gain in tax years after the death of the settlor or if the settlor becomes non-uk resident for tax purposes. The chargeable event certificate will contain all the information the trustees need to do this. Trustees of absolute trusts where the named beneficiaries are adults will not be required to make a declaration as the chargeable gains are taxable on the named beneficiaries. Where applicable, chargeable gains certificates are produced and there will be minimal ongoing paperwork. Regular withdrawals within trusts Investment bonds are able to provide a fixed level of regular withdrawals that some trust types require to be effective. Investment bonds can be very useful for trusts such as a Discounted Gift Trust or a Loan Trust. As investment bonds are non-income producing assets, income reinvested within the funds is not subject to the relatively high levels of trustee taxation. Trustees are able to make use of the 5% annual allowance in the same way as other investors. If withdrawals are kept within the 5% annual allowance, and no other chargeable events are triggered, there is no immediate tax liability for the trustees, settlor/donor or beneficiaries.
11 Trust schemes available for use with investment bonds Investment bond providers usually produce a range of trusts, some designed specifically for use with their investment bond offerings: Client need To reduce a future IHT liability by making a gift into trust. To have an element of control in how the money is invested for the benefit of beneficiaries. Potential trust solution Gift Trust A Gift Trust allows your client to put a sum of money under trust for beneficiaries in the future. Your client can also be a trustee and therefore will remain responsible for looking after the trust fund. Please see our Gift Trust webpage. To reduce a future IHT liability by making a gift into trust. To retain a level of regular withdrawals from the investment to provide an income. Discounted Gift Trust A Discounted Gift Trust can provide an immediate reduction in the size of your client s estate and also provide fixed regular payments for life or until the bond is exhausted. Please see our Discounted Gift Trust webpage. To restrict an IHT liability by giving away growth on an investment. To retain access to capital. Loan Trust A Loan Trust enables your client to make an interest free loan to trustees who can invest it on behalf of the beneficiaries. All growth is immediately outside of your client s estate meaning that the IHT bill doesn t increase. Your client can also request for the loan to be repaid at any time in the future so they still have access to their money. Please see our Loan Trust webpage. To ensure their estate is shared between their own children rather than those of their spouse s subsequent/previous marriage/registered civil partnership. To use up a nil rate band on death due to a spouse already being able to carry a nil rate band over from a previous marriage/registered civil partnership. Will Trust A Will Trust allows your client to pass an amount into a trust on their death rather than transferring it directly to their spouse. This type of arrangement can have many different uses and can still allow the spouse/registered civil partner access to the funds if needed. Please see our Will Trust webpage.
12 Most providers also provide both Absolute (sometimes referred to as Bare) trust and Discretionary trust versions of the trust types listed on page 11. Absolute trust (or Bare trust) Specific beneficiaries named and their shares defined at outset. Once the trust is set up a beneficiary cannot be removed, nor can their interest be altered. It is also not possible for any other beneficiaries to be added to the trust at a later date. Beneficiaries have a defined right to their share of both the income and capital of the trust fund immediately. However, a minor beneficiary cannot demand their entitlement as they lack the legal capacity to give a valid receipt. Treated as a potentially exempt transfer (PET) for IHT purposes. No periodic/exit IHT charges. Discretionary trust No named beneficiaries, only classes of potential beneficiaries, so no individual beneficiary has a right to anything, except at the trustees discretion. Trustees have absolute discretion over both income and capital of the trust fund and decide who gets what, when and how. Beneficiaries cannot claim access to the trust fund. If a potential beneficiary is made bankrupt, the trustee in bankruptcy cannot claim any part of the trust fund. Treated as a chargeable lifetime transfer for IHT purposes. May be subject to periodic/exit IHT charges. Flexible trust Two classes of beneficiary - named absolute beneficiaries and potential classes. Named absolute beneficiaries have a defined right to their share of any genuine income arising in the trust. Trustees retain discretion over the capital and can appoint in favour of either the absolute or potential class of beneficiaries, as they see fit. Treated as a chargeable lifetime transfer for IHT purposes. May be subject to periodic/exit IHT charges.
13 SIMPLICITY Easy to look after Your client will only be required to declare investment bond growth on an annual tax return if: a chargeable event occurs, and any resulting top sliced chargeable gain falls into your client s higher or additional rate tax band. The chargeable event certificate will contain all the information your client needs to do this. Simple client administration as there is no need to complete complex paperwork each year. Create a portfolio within one investment Investment bonds can offer many different funds, often over 100, and switching between them is very simple. The sale of units for a switch is not a disposal for tax purposes. Your client will not be out of the market during the switch. Normally there are no initial charges or switch charges. One investment provider to deal with, one annual statement, valuations available using one website or telephone call. No charges or tax due when switching funds. Additional investments Further investments, or top ups, can usually be added to an existing investment bond rather than having to take out a new one. These additional investments can take advantage of the bond s earlier start date for top slicing purposes. Multiple investments can be managed within a single bond. Top slicing can reduce the amount of chargeable gain on an additional investment, which could reduce liability to income tax. RDR and facilitated adviser charging With the advent of RDR, investment bonds are no longer able to pay commission to advisers where a personal recommendation is made. While some providers have decided to exit the investment bond market, a large number of providers remain and many offer the option to facilitate the payment of adviser charges. One payment required from client to provider to cover investment and payment of initial facilitated adviser charges. No requirement for client to set up regular payments to cover ongoing adviser charges as they can be deducted from the investment bond and paid direct to you.
14 WHY CHOOSE LEGAL & GENERAL s SELECT PORTFOLIO BOND? AIMING FOR GROWTH, INCOME OR BOTH Wide range of over 120 funds from 20 investment managers, including our own flagship index tracking and Distribution Funds (as at 20 September 2017). A choice of regular withdrawal types: A fixed amount of up to 10% of the initial investment each year. A variable amount of up to 10% of the bond s value each year. Natural income from Legal & General s Distribution Funds, Property Fund or High Income Fund. FLEXIBILITY Choose up to 10,000 policies to make up the bond (default of 100). Regular withdrawals can be started, stopped or changed at any time. No early cash in penalties. ESTATE PLANNING Range of estate planning/trust schemes: Gift Scheme (Discretionary, Flexible and Absolute versions). Discounted Gift Scheme (Discretionary and Absolute versions). Loan Trust Scheme (Discretionary and Absolute versions). Will Trust Solution. FACILITATED ADVISER CHARGING We offer your clients a way of paying for advice and related service charges through our Select Portfolio Bond. These are: An initial facilitated adviser charge: This is an amount deducted before investment is made into the bond. An ongoing facilitated adviser charge: This is a percentage of the bond s value each year deducted and paid to you on a monthly basis. This can be stopped, started or changed at any time. For an overview of the Select Portfolio Bond and the target market for this product please see the Adviser Guide. For more information please see our Select Portfolio Bond webpage. For more information about Legal & General and the range of products we offer, please visit our Adviser Centre.
www.legalandgeneral.com/advisercentre Legal & General Assurance Society Limited Registered in England and Wales No.00166055 Registered office: One Coleman Street, London EC2R 5AA Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Q40429 09/17 H0161133