Investment bonds are life insurance policies where you invest a lump sum in a variety of available funds. Some investment bonds run for a fixed term, others have no set investment term. When you cash investment bonds in, how much you get back depends on how well – or how badly – the investment has done.
Investment bonds also allow you to make regular withdrawals each year up to a specified limit. Withdrawals of up to 5% each year of the amount that you invested can be taken (maximum 20 years) without triggering any immediate tax liability. It is also possible to roll over any unused 5% withdrawals into future years where a larger withdrawal can be made.
However, it is important to note that the tax is in effect only deferred until the bond is cashed in. Withdrawals will be added to any profit made and taxed as income in that tax year.
This is calculated by using something called a ‘top-slice’ calculation. This works by taking the profit from the bond and dividing it by the number of years the bond has been held to create an average profit per year over the time held. When this figure is added to the holders other income for that year the final tax payable can be calculated.
If, after adding the top slice calculation the holders income remains inside the basic rate tax band there is no further tax to pay. However if the total income for the year exceeds the basic rate and enters higher rate, there will be additional tax to pay.
Another key feature is that investment bonds are assignable and therefore ownership can be transferred to another party.
This is beneficial as the holder could draw the income from the bond for many years and then transfer it to a basic rate taxpayer to be cashed in avoiding any tax charge on the bond.
Investment bonds are also covered by the Financial Services Compensation Scheme to 100% of their value rather than just £50,000 in other investment based products, making them more secure than other alternatives.
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