Child Taxation: 11. Insurance Bonds
Published / Last Updated on 11/08/2021
Insurance investment bonds are collective investment plans in the same way that a stock ISA or personal pension plan is.
Collective Investment
The stock ISA and personal pension can invest in a huge range of funds and direct stock holdings such UK, USA, European, Far East, China, Global equities, property, corporate bonds, government based index linked and fixed rate gilts and bonds. The difference being that pensions and ISAs have a totally different set of tax rules that apply i.e. they have a different ‘tax wrapper’.
This is exactly the same for insurance investment bonds. A full range of funds are available, they just have different tax treatment to ISAs and personal pensions i.e. they have a different ‘tax wrapper’.
Bond Taxation
In very simple terms, a bond does not produce income, so you pay no income tax on it when it receives or pays out a regular ‘income’ payment. It is not real ‘income’, withdrawals are all capital and growth withdrawals even when regular. You can withdraw up to 5% of the original investment each year e.g. if you withdrew 5% pa over 20 years, that would equate to 100% of the original investment and the balance remaining would be gains. The 5% pa is cumulative e.g. if you do not withdraw 5% pa for 10 years, then in year 10, you can withdraw 10 years X 5% i.e. 50% of the original investment without incurring an immediate tax liability.
Top Slicing
The insurance company fund itself does pay taxes on growth/gains but provided when you make withdrawals, any excess above the 5% pa or if you encash more than this e.g. the whole amount, the overall profit or gain is divided up into a profit per year, known as ‘the slice’.
‘The slice’ is then added to your income in that year and if your income including the slice is still within the basic rate tax band then no tax is due.
If the slice or part of the slice when added to your income takes you into the higher rate tax bracket, then the proportion of the slice (or the whole of the slice if all is in higher rate tax band) is a chargeable gain subject to tax. The proportion of the slice in the higher rate tax bracket is multiplied by the number of years you have held the bond to deliver the chargeable gain for tax. This margin is then taxed at 20% rather then 40% income tax.
Assignment of Bond
This is simply a changed of ownership i.e. you can assign the ownerships of your investment bond to a child or grandchild. When assigned to the child, the bond is treated as if they had owned the whole of the investments and gains from day 1.
Bring in the Children
Let us say you are a parent of a grandparent and you wish to invest in the longer term for children e.g. for university fees, weddings, gifts, house deposit etc. You invested in a insurance investment bond 10 years ago. Today your grandchild is heading to university and you want to help. You assign ownership of the bond to the grandchild/student and given the student is likely to have little or no taxable income, they can encash part or all of the bond and provided the yearly profit (slice) when added to their income is below the higher rate tax threshold, there is no tax to pay. The same can be done if they are getting married, buying their first car, house deposit etc.
Insurance investment bonds are yet another way to invest money and earmark it for children and grandchildren and make tax sense if you would like to keep control right up to when you choose to make a gift and assign the bond.
