Investors urged to get out of onshore investment bonds
Onshore investment bonds are losing their appeal as new tax rules for high income earners are being analysed. The Chancellor has recently announced new rules for the taxation of Britons earning £150,000 on the yearly gains from such investments. For next year, gains will be taxed at 50% meaning that other forms of investments will be more attractive as they will only be subject to capital gains tax at 18%.
Danny Cox, from Hargreaves Lansdown, is vociferous in his condemnation. He states that in his view the onshore bond has no appeal at all. His sentiment is mirrored by Tim Cockerill who is head of research at advisory company Rowan. He says that there is a simple choice between paying tax at 40% now and 50% in 2010 or 18%.
Independent Financial advisers (IFA's) have long benefited from generous commissions of 5% to 8% from the selling of these bonds and this has led to an estimated £4bn being invested. Many invest by way of lump sum payments into bonds issued by a wide variety of companies such as Standard Life, Prudential and Scottish Widows. The recent global fall in equity markets has given these bonds a new lease of life in the belief that they offer better returns. The most popular investment has been into with profits bonds but a continual stream of announcements that bonuses are being cut has dispelled that theory.
The inherent lack of flexibility and the ability of managers to add extra charges through Market Value Adjusters (MVA's) means that trying to move funds or cash them in leads to serious capital erosion of up to 20%. Adrian Shandley, managing partner of Premier Wealth Management, says that the death benefits can be attractive but he believes that the upsurge in buying with profits bonds is a short term phenomenon.
The arguments get confusing for those with complex financial planning requirements. Essentially those that will have not have used their full £10,100 capital gains tax allowance in 2009/10 then the benefits of onshore bonds are less obvious.
There is an ability to make a 5% of original capital withdrawal each year for 20 years without a liability to higher tax becoming due. But as with all tax, the liability is deferred rather than avoided altogether meaning that specialist advice is required for those looking to invest or withdraw. Basic rate taxpayers can still benefit but, warns Rowans' Cockerill, the logistics of setting up a regular withdrawal programme are complex.
Elderly investor's need to be aware that by cashing in an onshore bond can reduce age related state allowance benefits. Gains from bonds are classed as income so can cause someone's income to exceed to £22,900 limit at which benefits are reduced. If used as part of retirement planning then onshore bonds can provide a good means of passing on estate to heirs. If cash is needed for living purposes then may pensioners prefer capital gains related products.
Onshore bonds are not particularly tax efficient. Gains within the fund are subject to a standard rate tax deduction and higher rate payers will have a further tax liability of up to 30% from next year. Management fees are also levied at up to 2% per annum.
Where onshore bonds do have some value is in estate planning for inheritance tax purposes. Some money can be invested into 'discounted gift trusts' which provide immediate exemption from inheritance tax up to the threshold permitted. After 7 years, any additional funds invested also become potentially exempt but holders of the bonds can continue to take income in the meantime.
Unlike onshore bonds, the appeal of offshore bonds remains high. These are issued by UK companies and invest in a much wider range of funds than those permitted with onshore bonds. Whilst the minimum investment requirements are greater, they do provide a mechanism for high rate payers to defer their liability until they have moved into a lower rate band, for example, once they retire or emigrate to a more benign tax regime. The reason they differ is that they are governed by more favourable rules relating to life insurance policies.
Whilst complex it seems clear that the benefits of onshore bonds are being questioned by a number of experts. If you are affected or have money invested in onshore bonds you may wish to seek up to date advice from an independent advisor on your options before the new 50% tax rules come into force in 2010.