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Don’t forget the benefit of bonds

  • They can be used to reduce inheritance tax and capital gains tax liabilities
  • Tax changes in last November’s Budget make them more attractive to mass affluent investors

Research from investment, protection and retirement specialist LV= highlights how investors are potentially missing out on the benefits of investment bonds.

Changes to Capital Gains Tax (CGT) and tax-free dividend allowances make investing in bonds more attractive to mass affluent investors - those with assets of between £100,000 and £500,000 excluding property - who have used up other tax allowances. The tax-free CGT allowance will fall to £3,000 in April 2024 from £12,000 in 2022. The tax-free dividend allowance will fall to £500 in April 2024 from £2,000 in April 2022. 

Research conducted as part of the LV= Wealth and Wellbeing Research Programme reveals only a minority of investors understand bonds, even though they offer many tax benefits:

  • Some 18% (9m) of those who do not have bonds would consider investing in bonds. The demographic groups who are particularly interested include: mass affluent consumers, those with young children (aged 0-10) and those with a household income of £100,000 and over. 
  • Only one in 10 UK adults say they understand the tax rules about bonds 
  • Bonds can be used to reduce inheritance tax liabilities but only one in four bondholders has written their bond in trust, which means it would be considered as part of an estate for inheritance tax purposes.

The benefits of bonds

  • Onshore bonds are not liable to CGT. When calculating a chargeable gain, onshore bonds (such as the LV= Smoothed Bond) are treated as having already paid 20% tax on any gains. In reality, the tax deducted is likely to be less than this.
  • They can be ideal for inheritance tax (IHT) planning and can be exempt from IHT after seven years if held in a trust.
  • Investors can withdraw up to 5% of initial investment a year without triggering a chargeable event or any immediate tax liability.
  • Top slicing relief available to reduce tax liability, which can eliminate or significantly reduce any tax liability when a chargeable event is incurred – useful if clients are in accumulation phase and are preparing for retirement (may be a higher rate tax payer while owning the bond, but a basic rate tax payer when encashing). 
  • Options to assign a bond (for example, between husband and wife). For tax purposes, the assignment will generally be treated as if new owner had always owned - If one is a basic rate taxpayer, could possibly have no tax to pay on encashment.

 “Tax changes in November’s Budget have made investment bonds more attractive to investors. The Chancellor’s decision to reduce the Capital Gains Tax Allowance to £6,000 this year and to £3,000 in April 2024 means investment bonds are more attractive to mass-affluent investors who previously held money in OEICs and unit trusts.

“They will appeal to investors who want to reduce the amount of inheritance tax their estates pay when passing on wealth.  The inheritance tax nil rate threshold has been frozen at £325,000 since 6 April 2009 and with no future increases in sight, an increasing number of people will be looking at trusts as a way of keeping money outside of estates. 

“Investors who have used their ISA allowances and other tax-efficient wrappers, or who have received a large windfall payment – perhaps from an inheritance, for example - can also benefit.

“LV’s research indicates that most investors are confused about the benefits of investments bonds. The rules can be confusing. Bond investors are typically approaching retirement or are already retired and have a low risk approach to investing. They often are more concerned about conserving capital rather than taking on investment risk in the search for growth. 

“Financial advisers have an important role to play explaining the benefits of bonds to clients and helping them find an investment that matches their investment risk profile. LV’s range of Smoothed Managed Funds will appeal to investors with a lower appetite for risk because they offer the prospect of long-term growth while reducing short-term investment volatility using a unique smoothing mechanism that works by averaging daily unit prices over the previous 26 weeks.”

David StevensSavings and Retirement Proposition Director