Investment bonds versus unit trusts or open ended investment account (OEIC)

InvestmentsTaxation of:-

The UK Bond

Investment bonds are taxed under the ‘chargeable event’ legislation, which means that chargeable gains are assessed to income tax rather than Capital Gains Tax (CGT). The bonds suffer corporation tax inside the life fund. The actual rate paid within the fund will vary but the bondholder will be deemed to have paid tax in the fund at a rate equal to 20%, even when the actual rate is lower.

The Unit Trust or OEIC

UK open ended investment companies (OEIC) and unit trusts receive all UK dividends and pay distributions without having to account for tax. Such dividends, franked investment income, can be paid to investors with a notional 10% tax credit. All other forms of income, unfranked investment income, are subject to Corporation Tax at 20%. This could include interest, dividends from non-uk companies and rental income. They have an automatic exemption from tax on capital gains and pay corporation tax at 20% on taxable income.

The Bond Holder

On encashment a higher rate taxpayer will pay an additional 20% on the net gain, which means the maximum effective rate will be 40% (20%/20%). An additional rate taxpayer will pay an additional 25% on the net gain on encashment, which means the maximum effective rate will be 45% (20%/25%).

For basic rate taxpayers there is no further liability but there is no opportunity for non-taxpayers to reclaim any tax paid or use any unused personal allowance.

The Unit Trust or OEIC Investor

Income Tax is payable on interest and dividends arising from income and accumulation units. Income received is therefore taxed, even where re-invested, and is payable at the investor’s highest Income Tax rate.

The tax-free allowance for dividend income is £5000 (this reduces to £2,000 from 2018/19). The tax rates relating to dividend income in excess of this allowance are; 7.5% (basic rate), 32.5% (higher rate) and 38.1% (additional rate).

An annual exemption of £11,300 for individuals can be offset against any realised gains. A flat CGT rate of 10% (basic rate) or 20% (higher and additional rates) will apply to all realised gains on disposal of the investment for individuals above the exempt amount.

Advantages of the UK Bond

  • Bonds are non-income producing assets so there are no annual returns for individuals or trustees.
  • Fund switching giving no rise to CGT or Income Tax liability on the investor.
  • Switches in and out of funds are not subject to the CGT 30-day rule so will not give rise to a taxable event.
  • Gains can have something called top slicing applied which could reduce or remove any higher rate tax liability.
  • Bonds can be assigned or gifted away without giving rise to a tax charge, although Inheritance Tax (IHT) may apply.
  • A tax deferred allowance equal to 5% of the original investment can be taken each year without creating an immediate tax liability. If not taken in any one year they can be rolled up for future years.
  • For the purpose of age allowance, withdrawals of up to 5% tax deferred allowance are not treated as income.
  • Bonds can be set up in joint names at the outset to avoid a chargeable event on the first death.
  • Single premium investment bonds are not normally included where means testing is applied by local authorities for residential care.

Advantages of the Unit Trust or OEIC

  • Capital Gains Tax (CGT) rate of 10% and 20% for individuals (the rate used will depend on the amount of their total taxable income and gains), 20% for trustees or personal representatives and 10% for gains qualifying for Entrepreneur’s Relief.
  • The annual exemption of £11,300, (£5,650 for trustees) can be used to offset CGT (2017/2018 tax year).
  • Unused losses can be carried forward to offset against future gains.
  • Clear pricing.
  • Suitable for trust investments where beneficiaries are entitled to capital or income.
  • Switches within the fund will not give rise to CGT.
  • Gains realised whist non resident may not be liable to UK tax (subject to the duration of the non-residency).
  • The first £20,000 can be placed into a stocks and shares ISA.

Templegate covers the cost of the initial consultation.

So what next?

The only thing left for you to do is pick up the phone and call Templegate on 01264 300125 or 0345 833 8837, email or complete our enquiry form.

Templegate Financial Planning Ltd is an appointed representative of 2plan wealth management Ltd, which is authorised and regulated by the Financial Conduct Authority. 2plan wealth management Ltd is entered on the FCA register under reference 461598. The FCA do not regulate will writing services or some forms of mortgages and Inheritance Tax planning. The information and content of this website is intended for UK consumers only and is subject to the UK regulatory regime. Templegate Financial Planning Ltd. Registered Office: Winton House, Winton Square, Basingstoke, Hampshire, RG21 8EN Registered in England No. 04416499.