Are Investment Bonds Worth It?Posted on: 23 September 2008 by Gareth Hargreaves
Independent Financial Adviser Peter McGahan advises whether investment bonds are the best way to maximise your savings.
"Are investment bonds a good way to save and get a good return or are there more lucrative ways to save?"
An onshore investment bond is simply a tax wrapper that determines how anything invested into it is taxed. So for example you could invest into the same fund in a bond, ISA, or unit trust.
The fund would be identical but the charges and the taxation would mean that the investment would grow very differently, a point many advisers, let alone customers don’t necessarily grasp.
A bond pays basic rate tax as it grows and is the most tax disadvantageous way for the majority of investors to invest yet it seems it’s the default mode of investment - puzzling.
There could be a number of reasons for that - the fact that commission is as much as 8 per cent on a bond as opposed to 3 per cent on the others may be a factor, but let's hope not.
The recent changes in capital gains tax have nailed the coffin for investment bonds and I would be really surprised to see them used again.
The question will really be about whether or not investors should move out of the tax inefficient bonds they have or stay and independent financial advice is essential before making this decision as there are a range of tax consequences to consider.
But aren’t the charges cheaper?
Other issues to consider regarding a bond relate to the opacity, often taken advantage of by the unscrupulous. The charges are often hidden or at best disguised. The 'allocation rate' they mention is a lure and if you have ever used a lure when fishing you will realise there are a number of sharp hooks which apparently don’t hurt the fish.
Instead of taking an upfront charge of x per cent, the charge is hidden and charged to your investment over a period of 5 years typically.
Don’t believe it’s a bargain as the charge is reasonably steep. Ask your investment adviser if you disinvested the day after investing what the charge would be, and you’ll see the true impact of the charges, as they will hit you with the full fee at that point, which is often close to 9 per cent.
Many also disguise their charges within 'mirror funds' which you can read about by clicking here. These are basically more expensive versions of the best funds in the market which can best be described as a bad copy and the difference in buying the better fund or the copy could be a massive 12 per cent per year loss. Everyone I have met who is invested into mirror funds didn’t know it.
Aren't they more tax advantageous?
The tax is not advantageous at all. Study it and you’ll see that the tax break you are being offered is 5 per cent of your investment as an income per year over 20 years - that’s just your money back and is hardly a break.
What you also don’t see is that the investment fund is disadvantaged by paying tax as it grows and you can’t reclaim that. That’s more of a brake than a break.
There are other tax problems, such as when an over 65 year old encashes the investment, the gain is added to their income. That could cost them to lose their age allowance and an immediate tax charge of up to £719.
But surely they provide access to the best funds to invest into?
Most investment bonds have a limited range of funds, which are at the very best average. Some companies realise this and offer a large range of investment funds. One we looked at, had over 150 funds to choose from, but when I researched the actual investment performance, not one of the funds was on our buy list. They were simply a range of cheap funds to make you feel you were achieving an investment spread.
The more preferable options to consider are an ISA or unit trust.
An ISA allows for the investments inside it to grow free of capital gains tax but you are limited to just £7200 per person.
A unit trust has numerous breaks. You are allowed a capital gains allowance each year of £9600. This means that you can access £9600 each year without any liability to capital gains tax. If the gain is more than that, you can delay it for a year and use next year’s allowance. Remember that the allowance is per person and both husband and wife have one.
On that basis you could take 5 per cent per year per couple from a £384,000 investment, which would be completely tax-free.
Lastly a unit trust allows you to offset any gains or losses you have made elsewhere. If you have made a gain on your second investment property and your unit trust had gone down you could simply encash both in the same year and offset the loss against the gain. Consider all investment options before you decide what to invest into.
An investment bond would not give you that break at all. In fact it gives you none.
Before encashing an investment bond seek good independent financial advice.
In any event if you are invested into an investment bond you should also be reviewing its suitability as the recent budget nailed the coffin shut in terms of their ongoing competitiveness in terms of tax efficiency - not that they were ever tax efficient.
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