The longer good buys

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The Independent Online
SOME PEOPLE are not cut out for direct stock market investment. The government's tax-free ISA scheme may have grabbed all the headlines (not all flattering) but for those who prefer a more traditional way of investing, life companies still offer a range of products that are not tax-free but may be a good buy for cautious taxpayers.

You just have to be careful how you buy them. It is possible to avoid the hefty commission and charges if you know where to go.

In life companies, the most popular investment plans are endowment policies (often sold as a mortgage repayment vehicle), and with-profit investment bonds, which offer regular income without eating into capital investment.

The money you put into endowments and bonds is invested in their giant with-profits funds (so-called because they pay a share of the fund profits to investors each year). The managers invest in a mixture of shares, property and fixed-interest investments and the plans often include life insurance.

You may see with-profits plans - including friendly societies' savings plans - being billed as tax-free, but this is misleading. It means you will pay no further tax on your payout at the end of the policy. You have already paid tax in a roundabout way because the life company has to pay tax at 20 per cent on the profits it makes on the with-profits fund.

Non-taxpayers cannot reclaim this tax. Those on higher rate may be able to avoid paying more (17 per cent, the difference between the higher and basic rate) if they choose a regular savings policy that qualifies for tax exemption. Most policies (such as endowments) qualify under this rule. Any policy with a lifespan of more than 10 years is likely to be exempt from the extra tax.

If you choose a with-profits bond scheme and pay in a lump sum you may be able to avoid paying higher- rate tax on the regular income and on the proceeds when you cash it.

Patrick Connolly at Chartwell investment management in Bath says: "You can withdraw 5 per cent of the initial investment each year for 20 years. On the first 5 per cent you will be no immediate tax and for every 1 per cent you withdraw after that, you pay the excess rate of 17 per cent. If you're a higher-rate payer you can defer the tax bill until the end of the policy, by which time you might be a basic-rate taxpayer."

The big problem with these life company investments is the charges. Patrick Connolly says: "Generally, there is an initial charge of 5 per cent, which means if you are investing pounds 10,000, pounds 500 comes out on the first day. The reason is the heavy commission which must be paid to brokers."

You can save most of this by buying direct from a discount broker. Chartwell and Financial Discounts Direct, among others, offer this deal. On a with-profits bond from FD Direct, the discounts on the initial charge start at 4 per cent (of the full investment), and go up to 5 per cent or in some cases 5.5, depending on the company and the size of the investment.

Alan Penny, FD Direct's chairman, said: "For an investment of pounds 50,000- plus in Scottish Mutual's with-profit bond our discount would be 5.5 per cent, a saving of pounds 2,750.'' Another long-standing tax-free investment, particularly popular with grandparents saving for children, is the Friendly Society Bond. This is usually a with-profits investment. You are allowed to contribute a maximum of pounds 25 a month (or pounds 270 a year as a single premium) for 10 years, although some plans may run 20 or 25 years. Married couples can each invest their allowance into a single policy, effectively doubling contributions. There is no tax to pay on the final proceeds of the policy.

So far so good, particularly if you are a basic-rate or higher-rate taxpayer. But friendly society bonds are not recommended by many experts as a stunning investment.

Julie Lord, managing director of Cavendish Financial Services in Cardiff and a certified financial planner, says, "I don't think they are very good value for money. Their performance is not brilliant, they have relatively high charges and pathetic contribution rates."

The most popular way to get the benefits of life insurance products without paying through the nose is to buy a second-hand endowment policy. People sell when they get divorced, cannot afford them or no longer need the policy. You buy the contract and pay the regular premiums for the rest of the term.

The market in traded endowment policies (TEPs) has exploded. Some people buy them for the timing, so the maturity date when the policy pays out coincides with a specific event, such as retirement or entering university. You can get a TEP from a selection of dealers, or through an auction. Contact the Association of Policy Market Makers (0171-739 3949) for a list of member companies