Tax Changes 2023 Insurance Investment Bonds v Collective Investment Accounts

The Autumn Spring Statement Budget of 2022 made taxation when holding shares and dividends based collective investments such as General Investment Accounts (GIAs), Unit Trusts, OEICS and Investment Trusts less attractive:

• Tax-Free Dividend Allowance of £2,000 is being reduced from £2,000 to £1,000 in April 2023 and £500 in April 2024.
• The 1.25% NHS and Social Care levy was kept for dividend payments meaning dividends received about the Tax-Free Dividend Allowance stays when it was reduced for earnings at 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers.
• Capital Gains Tax Annual Allowance being reduced from £12,300 (2022/23) to £6,000 (2023/24) and just £3,000 (2024/25).

This has now reduced the thresholds where we believe investors should consider investing in Insurance Investment Bonds rather than collectives dramatically.  If we assume the average dividend is 3.5%pa, the maximum amount you should be holding in collectives and general investment accounts should be:

• 2022/23 = £57,142  (£57,142 X 3.5% dividend = £2,000 tax-free dividends on shares and collectives).
• 2023/24 = £28,571  (£28,571 X 3.5% dividend = £1,000 tax-free dividends on shares and collectives).
• 2024/25 = £14,285  (£14,285 X 3.5% dividend = £500 tax-free dividends on shares and collectives).
• Similar figures are delivered when you look at profits/gains and capital gains taxes.  For example, just a 21% return on your collective investment when you cash it in would take you over the capital gains tax annual allowance for 2024/25.  This type of movement/trading range regularly happens in stock markets each year.

Therefore, we believe insurance investment bonds should now be ‘back in fashion’ and should be many investors ‘go to’ investment forming the backbone of an investment portfolio alongside ISAs and general investment accounts up to the above suggested thresholds.

What is an Insurance Investment Bond?

An Insurance Investment Bond is a ‘non-qualifying’ (meaning potential taxable), whole of life insurance-based investment policy.

Insurance bonds invest in similar funds to those offered by other collectives such as ISAs, unit trusts and general investment accounts.  The difference between them all is simply that they have a different tax “wrapper” around them i.e., insurance bonds are taxed based upon rules from the Financial Act 1968 whereas ISAs, unit trusts and general investment accounts are now taxed per the new rules and limits detailed above and pension schemes are taxed entirely under yet another different set of rules, yet they all invest in similar areas and offer similar funds.

Insurance Investment Bond Rules

It is the life insurance fund that pays at 20% on gains/profits.  That said, and from experience whilst the writer (Ashley) was working for a major insurer, after offsetting losses and expenses, insurance funds usually pay tax at around 14% but are deemed to have paid 20% even when/if they don’t.

5% ‘income’ rule – investors are allowed to withdraw up to 5% pa of the original capital investment without any immediate income tax liability.  This means that over a 20-year period, you can with up to 5%pa i.e., at year 20 that is 100% of the original investments (20yrs X 5% = 100%) without any taxes to pay.  You can even defer the 5% pa withdrawals e.g., no withdrawals for 5 years means that in year 6, you could withdraw 30% of the original investment (5 years X deferred 5%s = 25% plus 5% for year 6).  After this, all that remains is the gains i.e., growth which may then be subject to income taxes.

Watch: Insurance Bonds Explained

Withdraw more than 5% pa or have used up your 5% allowances

If you withdraw more than 5% pa e.g., 7.5% pa or say at year 5 decided to withdraw 50% of the investment (i.e., over your 5% pa allowance) or you have used up all of your 5% pa allowance i.e., 100% of the original investment has already been taken, you may be subject to taxes.

But the insurance company fund is already deemed to have paid 20% tax.  This means that if you are:

• A basic rate taxpayer (20%), you pay no tax as 20% already deemed paid.
• A higher rate taxpayer (40%), 20% tax is payable as 20% already deemed paid.
• An additional rate taxpayer (45%), 25% tax is payable as 20% already deemed paid.

This is calculated using a method called “Top Slicing” where the average gain per annum is worked out i.e., not the total gain you are withdrawing but the average gain per year (gain divided by number of years held).  This is then added to your normal income and if you stay in basic rate tax band there is no tax to pay.  If you are a higher rate taxpayer or above, then 20% or 25% tax is applied to the taxable part of the slice and then multiplied by the number of years to work out the tax due.

Watch: Top Slicing Relief

This presents some welcoming tax planning opportunities for basic rate taxpayers and those that are higher rate taxpayers today but may become basic rate taxpayers in retirement or later.

Assignment

• If you transfer or give away your shares or collective general investment account to anyone other than your spouse or civil partner, you are liable to capital gains taxes on transfer.
• If you assign ownership and give away your insurance investment bond to anyone you are not liable to any taxes on transfer.  The bond work is treated as if it was owned from day 1 by the new owner.  This present fantastic estate, tax planning and school, university, or other funding opportunities.  E.g., your grandchild is to university.  You assign ownership of the bond to them.  You pay no taxes and your grandchild, assuming they are non-workers, low paid workers, or basic rate taxpayers, they will pay no taxes when they cash in the bond e.g., to pay university fees, accommodation fees, student loans or even a deposit for a house.
• Insurance investment bonds can be placed inside trusts for estate, tax and inheritance tax planning.

Watch: Insurance Bond Assignment

Financial Services Compensation Scheme

• Collective general investment schemes have a maximum £85,000 compensation limit if the investment firm becomes insolvent.
• Insurance investments bonds have 100% compensation protection with no upper limit as they whole of life insurance-based investments.

Social Care Fees Means Test

• Collective general investment schemes are included in the capital means test for payment of social care fees.
• Insurance investment bonds are currently not included in the capital means test for payment of social care fees provided you are not taking regular withdrawals.  This is specifically detailed in the Government’s Charging for Residential Accommodation Guide (CRAG) issued to all local authorities specifying how each local authority should charge for residential care.

Our favourite investment vehicle is the insurance investment bond, and we believe it is about to have a renaissance when the above tax changes come into force in April 2023.  Contact us for tax saving ideas and how best to construct or re-construct your investment portfolio.

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