Personal Finance: Bond, licensed to kill tax

HANDS UP anyone who likes paying tax. It is probably true to say that almost no one does so with any great sense of joy. Hence the likely long-term attraction of tax-free wrappers available on the new Individual Savings Account (ISA) that was launched by the Treasury earlier this month.

With-profits bonds don't have the same immediate tax benefits of ISAs or the PEPs that were replaced by ISAs. However, if they are judiciously used, with-profits bonds can be used to defray or even to reduce people's tax liabilities.

However, first you need to ask: what exactly is the tax position of a with-profits bond? Essentially, it is a "tax-paid" investment, in that it is already subject to a basic rate of tax, after deductions for expenses, within the life fund in which it is invested.

Higher-rate taxpayers will face an additional demand when they encash their bond. This also means that, for non-taxpayers, the fact that they can reclaim tax if they keep their savings in a bank or building society account means a with-profits bond may not be generally suitable.

However, the fact that with-profits bonds are treated as a life insurance bond means that current rules allow up to 5 per cent of a bond's original investment to be taken as income each year, without any further tax liabilities, for up to 20 years.

This is based on the assumption that, over a 20-year period, the total capital investment could be returned - and the Inland Revenue regards this "income" as capital being returned. Any further liability is deferred until the bond is encashed.

Higher-rate taxpayers can take advantage of these rules by waiting until they move back into a lower tax band (at the time that they retire, for example) before they encash their bond. This would make them liable to no more tax at this point. Meanwhile, there is no capital gains tax to pay on any growth in the value of the investment itself.

Moreover, the 5 per cent "capital as income" rule is particularly effective when used by taxpayers over 65. This is because anyone over normal retirement age receives an allowance of pounds 5,720 (in the 1999/2000 tax year) before any tax is paid. This mounts to pounds 5,980 for anyone aged 74 or over. This adds pounds 1,385 to the standard tax break of pounds 4,335 for anyone aged over 65 and pounds 1,645 for those aged over 75.

However, there is a sting in the tail: for anyone earning over pounds 16,800 a year, this excess allowance is taken away at the rate of pounds 1 for every pounds 2 earned, so that anyone under the age of 75 earning more than pounds 19,570 loses that allowance entirely. In effect, this amounts to a marginal rate of tax of more than 34 per cent on that sum.

But not if you are taking income from a with-profit bond. Because it is not classed as total income by the Inland Revenue, no allowance is lost. It should be noted that, when the bond is finally cased in, each of the 5 per cent slices taken in previous years may be added to the total current value of the policy to check any tax liability. But only borderline or higher-rate taxpayers need worry.

Also, at encashment each of the 5 per cent slices taken will be counted towards "total income" for that year. This means losing a proportion of the age-related allowance in that year. But the amount gained by the annual addition of income through the with-profits bond should easily cancel out that final year's loss of allowance.

`The Independent' has produced a free 24-page `Guide to With-Profits Bonds'. Written by Nic Cicutti, this paper's personal finance editor, it examines the arguments for and against investing in bonds. For your copy of the guide, sponsored by The With-Profits Bond Shop, call 0845 2711007.

Suggested Topics
PROMOTED VIDEO
Have you tried new the Independent Digital Edition apps?
Life and Style
ebooksA superb mix of recipes serving up the freshest of local produce in a delicious range of styles
Life and Style
ebooksFrom the lifespan of a slug to the distance to the Sun: answers to 500 questions from readers
News
REX/Eye Candy
science
News
A photo of Charles Belk being detained by police on Friday 22 August
news
News
i100
Sport
Alexis Sanchez celebrates after scoring his first goal for Arsenal in the Champions League qualifier against Besiktas
sportChilean's first goal for the club secures place in draw for Champions League group stages
Arts and Entertainment
Amis: 'The racial situation in the US is as bad as it’s been since the Civil War'
booksAuthor says he might come back across Atlantic after all
Extras
indybest
Life and Style
Google Doodle celebrates the 200th birthday of Irish writer Sheridan Le Fanu
tech
Arts and Entertainment
Vinyl demand: a factory making the old-style discs
musicManufacturers are struggling to keep up with the resurgence in vinyl
News
i100
News
In Eternal Sunshine of the Spotless Mind Jim Carrey and Kate Winslett medically erase each other from their memories
scienceTechnique successfully used to ‘reverse’ bad memories in rodents could be used on trauma victims
Arts and Entertainment
Singer Pixie Lott will take part in Strictly Come Dancing 2014, the BBC has confirmed
tv
Independent
Travel Shop
the manor
Up to 70% off luxury travel
on city breaks Find out more
santorini
Up to 70% off luxury travel
on chic beach resorts Find out more
sardina foodie
Up to 70% off luxury travel
on country retreats Find out more
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs General

    C# Developer (C#, ASP.NET Developer, SQL, MVC, WPF, Real-Time F

    £40000 - £48000 per annum + benefits+bonus+package: Harrington Starr: C# Devel...

    C# Swift Payment Developer (C#, ASP.NET, .NET, MVC, Authorize.N

    £45000 - £60000 per annum + benefits+bonus+package: Harrington Starr: C# Swift...

    Front-End Developer (JavaScript, HTML5, CSS3, C#, GUI)

    £55000 - £70000 per annum + Benefits + Bonus: Harrington Starr: Front-End Deve...

    Graduate C# Developer (.NET, WPF, SQL, Agile, C++) - London

    £30000 - £40000 per annum + Benefits + Bonus: Harrington Starr: Graduate C# De...

    Day In a Page

    Israel-Gaza conflict: No victory for Israel despite weeks of death and devastation

    Robert Fisk: No victory for Israel despite weeks of devastation

    Palestinians have won: they are still in Gaza, and Hamas is still there
    Mary Beard writes character reference for Twitter troll who called her a 'slut'

    Unlikely friends: Mary Beard and the troll who called her a ‘filthy old slut’

    The Cambridge University classicist even wrote the student a character reference
    America’s new apartheid: Prosperous white districts are choosing to break away from black cities and go it alone

    America’s new apartheid

    Prosperous white districts are choosing to break away from black cities and go it alone
    Amazon is buying Twitch for £600m - but why do people want to watch others playing Xbox?

    What is the appeal of Twitch?

    Amazon is buying the video-game-themed online streaming site for £600m - but why do people want to watch others playing Xbox?
    Tip-tapping typewriters, ripe pongs and slides in the office: Bosses are inventing surprising ways of making us work harder

    How bosses are making us work harder

    As it is revealed that one newspaper office pumps out the sound of typewriters to increase productivity, Gillian Orr explores the other devices designed to motivate staff
    Manufacturers are struggling to keep up with the resurgence in vinyl records

    Hard pressed: Resurgence in vinyl records

    As the resurgence in vinyl records continues, manufacturers and their outdated machinery are struggling to keep up with the demand
    Tony Jordan: 'I turned down the chance to research Charles Dickens for a TV series nine times ... then I found a kindred spirit'

    A tale of two writers

    Offered the chance to research Charles Dickens for a TV series, Tony Jordan turned it down. Nine times. The man behind EastEnders and Life on Mars didn’t feel right for the job. Finally, he gave in - and found an unexpected kindred spirit
    Could a later start to the school day be the most useful educational reform of all?

    Should pupils get a lie in?

    Doctors want a later start to the school day so that pupils can sleep later. Not because teenagers are lazy, explains Simon Usborne - it's all down to their circadian rhythms
    Prepare for Jewish jokes – as Jewish comedians get their own festival

    Prepare for Jewish jokes...

    ... as Jewish comedians get their own festival
    SJ Watson: 'I still can't quite believe that Before I Go to Sleep started in my head'

    A dream come true for SJ Watson

    Watson was working part time in the NHS when his debut novel, Before I Go to Sleep, became a bestseller. Now it's a Hollywood movie, too. Here he recalls the whirlwind journey from children’s ward to A-list film set
    10 best cycling bags for commuters

    10 best cycling bags for commuters

    Gear up for next week’s National Cycle to Work day with one of these practical backpacks and messenger bags
    Paul Scholes: Three at the back isn’t working yet but given time I’m hopeful Louis van Gaal can rebuild Manchester United

    Paul Scholes column

    Three at the back isn’t working yet but given time I’m hopeful Louis van Gaal can rebuild Manchester United
    Kate Bush, Hammersmith Apollo music review: A preamble, then a coup de théâtre - and suddenly the long wait felt worth it

    Kate Bush shows a voice untroubled by time

    A preamble, then a coup de théâtre - and suddenly the long wait felt worth it
    Robot sheepdog technology could be used to save people from burning buildings

    The science of herding is cracked

    Mathematical model would allow robots to be programmed to control crowds and save people from burning buildings
    Tyrant: Is the world ready for a Middle Eastern 'Dallas'?

    This tyrant doesn’t rule

    It’s billed as a Middle Eastern ‘Dallas’, so why does Fox’s new drama have a white British star?