With speculation mounting after the Office for Tax Simplification (OTS) report last week that capital gains tax (CGT) rates should be increased to income tax rates and where CGT does not currently apply on death as inheritance tax (IHT) may be payable at that point and that this is also likely disappear i.e. you may pay CGT on death before any IHT is calculated, we have looked at another likely impact.
Many people (and advisers) use general investment accounts to manage client savings. These (usually) grow over time in value and each year you, your adviser or your investment platform then ‘cashes in’ enough of your investment holdings to ‘Bed and ISA’ overnight i.e. dispose of enough investments to use your capital gains tax annual exemption and then reinvest in exactly the same investment funds the next day but now inside your yearly ISA allowance to make investments tax efficient.
If CGT rates increase, this may dramatically reduce the use of general investment accounts and push people back to insurance investment bonds.
Why Insurance Investment Bonds?
5% of the original investment can be withdrawn each year without creating an immediate liability to tax and is cumulative. E.g. if you invest in a bond and make no withdrawals for a period then both basic rate and high rate tax payers can withdraw up e.g. 25% (5 years X 5%) of the original amount invested without any immediate liability to tax (as the growth is left in the fund) and 50% (10 years X 5%) of the original amount invested without any immediate liability to tax (as the growth is again left in the fund). It is only after 20 years (20 years X 5% = 100% of original amount withdrawn that chargeable gains taxes may be payable. This is excellent for managing tax affairs.
For basic rate tax payers when they make withdrawals, they would not attract income tax rates when you cash in as a basic rate tax payer. Basic rate tax payers (after a ‘top slicing’ calculation is made), are not liable to further taxes as basic rate tax is deemed to have been paid as the investment fund itself has already paid taxes (usually around 10%-15% when you offset losses and gains).
For higher rate tax payers when they make withdrawals, they would not attract income tax unless the 5% limits were breached and then only pay 20% marginal/additional taxes on gains as 20% is already deemed to be paid and therefore 20% tax margin is payable to take it up to 40% is payable.
It is therefore a sensible option for higher rate tax payers to use investment bonds where withdrawals of up to 5%pa could be made as an ‘income’ if needed (or roll it up) whilst higher earners and then, if they are likely to be basic rate tax payers in retirement, they can cash in the bond when they do not have such a large taxable income and fall into a lower bracket were no tax may be payable.
In addition, bonds can be assigned ownership to another and then treated from a tax perspective, as if the new ‘owner’ had the investment from day 1. E.g. 40% tax, higher earning person invests in an insurance investment bond. When their child/grandchild is 18 and going to university, the bond can have ownership assigned to the student and if they then encash to fund university fees, accommodation, get married, buy a car etc when they are non-earners or low earners, again no taxes may be payable.
Insurance bonds can also be placed in a wide range of trusts to protect from or reduce inheritance taxes with no capital gains tax payable.