Tax break on bonds poised to bite the dust

With insurance products expected to lose a big selling point, Simon Hildrey asks how investors should respond

Savers may have just a little over a month to take advantage of one of the main benefits of insurance bonds. It is widely predicted that the Chancellor will use his next Budget to rescind the rule that lets policy- holders defer tax on 5 per cent of their original investment in the bonds every 12 months by taking it as income.

Savers may have just a little over a month to take advantage of one of the main benefits of insurance bonds. It is widely predicted that the Chancellor will use his next Budget to rescind the rule that lets policy- holders defer tax on 5 per cent of their original investment in the bonds every 12 months by taking it as income.

Abolition of the 5 per cent withdrawal rule would affect not only savers seeking income, but also trusts taken out to mitigate inheritance tax liabilities, many of which use insurance bonds. And with about £20bn invested in insurance bonds last year, a lot of people will be hit.

Insurers argue that savers wishing to exploit either benefit should consider taking out an insurance bond before 5 April, the end of the tax year. Even if Gordon Brown does change the rules, it is unusual for tax legislation to be enacted retrospectively. So it could be the last opportunity to get the benefit.

The insurance industry expects the rule to be abolished because this was the recommendation of Ron Sandler in his review last year of the £800bn long-term savings market. He argued that the 5 per cent withdrawal allowance should be removed because investment decisions should not be determined by tax considerations. He also thought it regressive as "its benefits are focused on higher-rate taxpayers".

In his pre-Budget statement last autumn, Mr Brown said he was looking to take forward Mr Sandler's recommendations on tax. Since then, the Association of British Insurers, which represents the insurance industry, has met the Inland Revenue to discuss whether and how the rule change should be implemented.

The withdrawal rule allows investors to put off paying income tax on 5 per cent of their original investment for 20 years or until they cash in their policy. Higher-rate taxpayers benefit in particular, as gains within bonds are taxed at the basic rate of 22 per cent. Another 18 per cent is levied only on gains for higher-rate payers when they cash in their bonds.

The insurance industry is naturally opposed to the abolition of the rule. Steven Whalley, product marketing manager at Scottish Equitable, says the bonds have a "simple tax status" as well as benefits: "Savers do not have to fill out a self-assessment tax form or notify the Revenue of gains from an insurance bond, as they do with unit trusts."

Colin Jelley, marketing development manager at Skandia, says: "If savers want to use the withdrawal rule and have the money to invest, they should buy a bond now. They can invest in cash and bonds if they do not want to risk equities at the moment."

He argues that even if the Government does not introduce retrospective legis- lation, it may not allow top-up investments on existing policies to benefit from the 5 per cent allowance.

Investors are being advised that in case the rule is changed and this is done retrospectively, they should buy bonds with no exit charges.

Mr Jelley is critical of the planned change as "it flies in the face of government attempts to simplify savings products, including pensions. The Revenue is likely to use a part disposal formula to calculate tax on insurance bonds in future, but this could be more complicated than the current situation."

According to Mr Jelley, the part disposal rule would calculate the level of tax to be levied on insurance bonds through a complex mixture of the income taken and the gain achieved. If a policy grew in value by 5 per cent every year and was cashed in after 10 years, Mr Jelley argues that the tax bill would be the same under part disposal as it is under the current system.

The difference is that tax would have to be paid every year on gains rather than only when the bond is encashed. This would have a negative impact on retirees, as it would reduce their personal allowance and force the over-65s to pay more tax.

While Adrian Shandley, director of the independent financial adviser Premier Wealth Management, believes this is a bad time to abolish the withdrawal rule, he argues that investors might be better off with unit trusts anyway.

"In a unit trust, an investor can offset losses in one year against gains in another, which you cannot do in insurance bonds," he says. "Gains in unit trusts are taxed as capital gains rather than income. Investors can use their allowance of returns of £7,700 a year free from capital gains tax. Fund managers within insurance bonds pay capital gains tax that cannot be reclaimed."

As if the situation wasn't bad enough already, Mr Shandley sounds another warning for with-profits policyholders: "Growth in bonds is supposed to exceed the 5 per cent withdrawal a year. But as with-profits bonus rates have come down, policyholders need to ensure a 5 per cent withdrawal is not eating into their capital."

PROMOTED VIDEO
Have you tried new the Independent Digital Edition apps?
Voices
voices
Sport
Roger Federer is greeted by Michael Jordan following his victory over Marinko Matosevic
tennisRoger Federer gets Michael Jordan's applause following tweener shot in win over Marinko Matosevic
News
peopleJustin Bieber accuses paparazzi of acting 'recklessly' after car crash
Arts and Entertainment
Oppressive atmosphere: the cast of 'Tyrant'
tvIntroducing Tyrant, one of the most hotly anticipated dramas of the year
News
i100
Finacial products from our partners
Property search
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 Money & Business

    Client Services Executive / Account Executive - SW London

    £23000 - £26000 per annum: Ashdown Group: Account Executive / Client Services ...

    PA to CEO / Executive Secretary

    £36000 - £38000 per annum: Ashdown Group: Executive PA to CEO & Executive Dire...

    Generalist HR Administrator, Tunbridge Wells, Kent - £28,000.

    £25000 - £28000 per annum: Ashdown Group: Generalist HR Administrator - Tunbri...

    Senior C# Developer (.NET, C#, JMS, TDD, Web API, MVC, integrat

    £45000 - £75000 per annum + benefits+bonus+package: Harrington Starr: Senior C...

    Day In a Page

    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?
    Rachael Lander interview: From strung out to playing strings

    From strung out to playing strings

    Award-winning cellist Rachael Lander’s career was almost destroyed by the alcohol she drank to fight stage fright. Now she’s playing with Elbow and Ellie Goulding
    The science of saturated fat: A big fat surprise about nutrition?

    A big fat surprise about nutrition?

    The science linking saturated fats to heart disease and other health issues has never been sound. Nina Teicholz looks at how governments started advising incorrectly on diets
    Emmys 2014 review: Can they genuinely compete with the Oscars

    Can they genuinely compete with the Oscars?

    The recent Emmy Awards are certainly glamorous, but they can't beat their movie cousins
    On the road to nowhere: A Routemaster trip to remember

    On the road to nowhere

    A Routemaster trip to remember
    Hotel India: Mumbai's Taj Mahal Palace leaves its darker days behind

    Hotel India

    Mumbai's Taj Mahal Palace leaves its darker days behind
    10 best pencil cases

    Back to school: 10 best pencil cases

    Whether it’s their first day at school, uni or a new project, treat the student in your life to some smart stationery
    Arsenal vs Besiktas Champions League qualifier: Gunners know battle with Turks is a season-defining fixture

    Arsenal know battle with Besiktas is a season-defining fixture

    Arsene Wenger admits his below-strength side will have to improve on last week’s show to pass tough test
    Pete Jenson: Athletic Bilbao’s locals-only transfer policy shows success does not need to be bought

    Pete Jenson: A Different League

    Athletic Bilbao’s locals-only transfer policy shows success does not need to be bought
    This guitar riff has been voted greatest of all time

    The Greatest Guitar Riff of all time

    Whole Lotta Votes from Radio 2 listeners
    Britain’s superstar ballerina

    Britain’s superstar ballerina

    Alicia Markova danced... every night of the week and twice on Saturdays
    Berlin's Furrie invasion

    Berlin's Furrie invasion

    2000 fans attended Eurofeurence
    ‘It was a tidal wave of terror’

    ‘It was a tidal wave of terror’

    Driven to the edge by postpartum psychosis