Switching can be fun with a bond

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INVESTORS who want to put their money into unit trusts are sometimes advised to choose insurance bonds instead.

They are variously known as insurance bonds, capital investment bonds, and various other titles, but their official title is single premium, non-qualifying, life insurance policies. Essentially they are unit trusts wrapped up in a notional life insurance policy.

The amount of life insurance is minimal; a guarantee to pay at least 101 per cent of the amount invested on death. The guarantee is to bring the contract within tax and investment rules for life insurance policies.

Advisers typically get more than 5 per cent commission on life insurance bonds, compared to 3 per cent on unit trusts. So the first point to agree with an adviser is that they will reduce their commission to 3 per cent and ensure that your investment is enhanced accordingly.

Cynics say it is only the higher commission that makes advisers recommend insurance bonds but there are other arguments in their favour.

The tax advantages are the most often quoted. Investors can withdraw up to 5 per cent of the amount originally invested without any further immediate charge to tax. Both the income and the capital growth will already have suffered tax roughly equivalent to basic rate charged on the insurance company's funds. The final encashment of the policy also results in a further tax charge of 15 per cent for higher rate taxpayers.

As a result, the tax advantages are limited. The exact balance of advantage depends on the balance between growth and income, since capital gains are more harshly taxed in a life insurance bond, whereas income is treated beneficially compared to a unit trust. Higher rate taxpayers who regularly use their capital gains tax allowance each year will be the main beneficiaries.

There is a better argument for insurance bonds if the investor likes to switch between funds and markets. A bond will normally allow investors to switch between a dozen or more funds either with no charge or only a few pounds to cover administration.

By contrast, although unit trusts may give a discount on their normal charges, there is still likely to be a cost of about 2 per cent in capital value on a switch.

Another advantage of insurance bonds is flexibility. Unit trusts have a rigid and statutory basis to their prices, and still have some restrictions on their investment capability. Insurance bonds are far less limited. This has led, for example, to 'with profits' bonds from insurance companies, where capital remains notionally 'guaranteed' and a bonus is declared each year.

In practice, these products are not quite as transparent as they sound. But with profits bonds still have an appeal to some investors and could not be easily duplicated in a unit trust.

Finally, Danby Bloch, of specialist financial publishers Taxbriefs, points out that insurance bonds are very good investments for trusts. 'Because they do not produce an income, there are no trust tax returns to complete. Not worrying about the income having to be paid to certain beneficiaries, or taxed at an additional rate, makes the trust more flexible,' he says.