Onshore bonds: a product of the past or tax wrapper of the future?

Onshore bonds were once the tax wrapper of choice, but in recent years international investment bonds and collective investments have been favoured by many advisers and their clients. But with capital gains tax changes in the offing, and a greater need for holistic tax planning, could onshore bonds be about to have their day in the sun once again?

With rumours that Rishi Sunak will be announcing wholesale changes to the capital gains tax (CGT) regime in the Spring Budget, it is even more important that clients maximise their tax allowances this year. This gives advisers an extra reason to encourage their clients to take a holistic financial planning review, and an opportunity to explore the tax wrappers available to them.

One such wrapper is the onshore bond. Ahead of any changes to CGT, advisers should give onshore bonds serious consideration since they are not subject to CGT while invested or on encashment. Indeed, when you look closely at onshore bonds, there are several compelling reasons to give them a place in your centralised investment proposition.
 

Tax advantages

Onshore bonds are used as a tax planning tool because:

• Your client can withdraw up to 5% of the amount invested each year without incurring an income tax charge at that time, and the allowance can be carried forward each year if they don’t use it. Please note though, that any adviser fees paid from the bond count towards this allowance, and no further allowance is available once the bond reaches it’s 20th anniversary.
• Onshore bonds are not liable for CGT while invested or on encashment because they are taxed under ‘chargeable event legislation’ to which income tax applies. They are only subject to income tax when a chargeable event occurs, such as cashing the bond in full or withdrawing more than the available 5% cumulative annual allowance. 
• Your client can put their bond into a trust, which may allow the settlor to take income or make capital withdrawals from the bond, while any investment growth is free from inheritance tax, depending on the type of trust used. Or they can gift it immediately to a beneficiary. The beneficiary can take an income from the bond, and any investment growth is outside of the client's estate. The gift is fully outside of the donor’s estate after seven years. 
• If your client makes a partial withdrawal and incurs a chargeable event, any gain made might be able to be averaged.

Greater flexibility and control

Onshore bonds are written as life insurance policies, which offers clients several advantages:

• The bond does not have a maturity date, so your client can decide when/if they sell the investment. 

• It can be written with several ‘lives assured’, so if your client holds a bond and is one of the lives assured, the bond can continue when your client dies due to other lives assured surviving. Ownership of the bond would pass as per the terms of any Will or under intestacy rules. 

• If your client is a trustee, higher-rate or additional-rate taxpayer, they can manage the timing of when a chargeable event arises to coincide with paying tax at a lower rate, perhaps in retirement for example.  

• Since the bond is segmented into many individual policies, they could assign ownership to another person or beneficiary who does not pay tax or pays at the basic rate.

• Because investment gains are not subject to CGT, clients can switch funds within the bond without incurring a tax charge.

Less administration

Onshore bonds do not have to be included in a client’s tax return unless a chargeable event arises. If a chargeable event occurs, the insurer will issue a chargeable event certificate showing any gain. 

A case study: minimising CGT, income tax and IHT while taking an income

A retired couple who are both in good health wish to take a regular income in the most tax-efficient way possible. Here is an overview of their current situation:
 

Proposal 

1. Keep the cash lump sum to use as an emergency fund for unforeseen circumstances. 

2. Sell £200,000 worth of assets in the investment account where CGT and income tax will be due on sales and distributions (at a maximum rate of 20% CGT as higher-rate taxpayers, 32.5% for dividends and 40% on other income, plus an IHT liability of 40% of assets over the prevailing nil rate bands). The clients could use their CGT annual exemption of £12,300 each to set against any gains, and £2,000 dividend allowance each set against dividend income tax. 

3. Retain £130,000 within the investment account so that the clients can utilise their £2,000 dividend allowance for this tax year. On a 3% yielding portfolio, this would provide a joint dividend income of £3,900 within this allowance. 

4. Maximise the ISA allowance of £20,000 each for the 2020/21 tax year and opt to take the tax-free natural distributions from the underlying assets to help supplement their income.

5. Invest £160,000 of the proceeds in an onshore investment bond. Taking 4% tax deferred withdrawals would yield an ‘income’ of £10,300 (made up of £3,900 in dividends and £6,400 bond withdrawals). 

6. If IHT becomes a concern, the bond could be gifted to trust to help reduce the liability. The type of trust would depend on what access the clients require.

The result

• Increase non-pension income from £9,900 to £10,300 without paying additional tax. 
• Utilise the tax and savings allowances, making their investments more tax efficient.
• Minimise exposure to CGT should the rules change.
• Clients are well positioned for IHT planning if they gift the bond into trust.

atomos accepts no liability for any action taken or not taken by an individual or firm as a result of the contents of this material. The tax treatments and information contained in this document is based on current tax law and HMRC practice as at January 2021 and may be subject to change in the future. 

Whilst we have made every effort to ensure the accuracy of this material, we cannot accept responsibility for any consequence (financial or otherwise) arising from relying on it. This document is for information purposes only and should not be treated as advice and independent taxation advice should be always sought.
Investing involves risk.

The value of investments, and the income from them, may fall as well as rise. Investors may not get back the original amount invested. Past performance is not a reliable indicator of future results.