Running out of money in retirement may be one of the greatest fears an investor faces. To avoid this danger, investors likely need to plan how to distribute their retirement income over their entire lifetime. But no one can know exactly how long they might live. For this reason, some investors may look for dependable, long-lasting income sources to cover their essential expenses. If you are willing to invest a lump sum for the long term, and understand the risk of the underlying investments, one option you may consider is investment bonds.
Investment bonds are single-premium life assurance policies sold by either a UK (onshore) or overseas (offshore) life insurance company. They are insurance wrappers that can be used as investment vehicles you can use to take regular income or be placed in trust for estate planning. The investment value can fluctuate with market movements. With most bonds, if the investments don’t perform well you could lose part of your original investment.
Investment bond providers may offer a variety of fund choices. Some focus on capital growth, some on income and some on growth and income. You also can usually choose to switch between funds.
An investor can choose between onshore and offshore investment bonds. The main difference is tax treatment.
Onshore: Any gains within the investment bond are subject to income tax, not capital gains tax, and are treated as tax-deferred whilst still invested. You can withdraw up to 5% per year out of your investment bond without incurring additional taxes. However, in the event of chargeable events such as death, transfer of ownership, maturity of bond, bond encashment or withdrawal beyond the 5% per annum allowance, you may trigger a tax liability.* Any UK-based dividends may not be subject to taxes, but you may face taxes on foreign dividends. Investors could face a deferred tax liability. Depending on the profits you take from the investment bond, you may be subject to an additional or higher tax rate tax liability. This can be mitigated through top-slicing relief, which allows the investor to spread the effect of the investment gains over the number of years the bond is held, on encashment.
Offshore: These may be issued from tax havens such as the Isle of Man, Luxembourg or the Channel Islands, and might offer a wider selection of funds. Investors may not have to pay UK income or capital gains tax on the underlying investment while the plan is in force, including dividends. However, you may not be able to reclaim any tax credits.
If you are considering using investment bonds as a tax wrapper, weigh the benefits and restrictions carefully. One of the primary benefits of investment bonds is their potential tax advantage, but the advantages may vary based on your personal situation.
You may be able to assign the bond to another party without triggering a chargeable event, as long as no cash transaction occurs. You may also potentially arrange for someone to receive a benefit upon your death. Death benefit situations may or may not be considered a taxable event—check the specifics of an investment bond to learn more.
Minimum investments: The minimum lump sum is usually between £5,000 and £10,000. Some providers offer the option to make additional regular payments.
Minimum investing terms: Investment bonds can be whole life or term life policies. There is usually no minimum investing term, although surrender penalties may apply in the early years.
Allowed withdrawals: Each year, you can withdraw up to 5% of the amount you have paid into your bond, for a maximum of 20 years, without paying immediate personal income tax. You can carry forward any unused part of this allowance to future years, not to exceed 100% of the amount paid in. If you withdraw more than the allowance or encash your bond entirely or partially, you may have to pay income tax on any gains. This can get complicated, so it is best to consult a tax adviser for guidance on a specific situation.
Death benefits: Your investment bond may pay out slightly more than the value of the fund if you die during its term.
Early withdrawal charges: Investment bonds are a long-term investment. If you cash in within the first few years of owning the bond, you may pay high exit penalties.
Investment choices and limitations: Depending on how much you invest, you will be allocated a number of units in the funds. You can invest in a range of funds, a portfolio or a mixture of both. Funds may invest in a specific asset, such as fixed interest, or a variety of asset classes. Because the value of your investments varies with the underlying assets, you may consider diversifying your investment fund selection. However, unless you have opted for a guarantee, which some investment bonds offer at extra cost, the potential still exists that you may not get back the amount you invested.
Charges: Charging structures of investment bonds may include provider charges, fund charges and adviser charges. There may be additional charges for guaranteed returns or other add-on benefits, or if you frequently switch between investment funds.
When assessing your net worth and long-term investment strategy, look at all of your potential income sources and options. When considering your decision, weigh asset returns, interest rates, tax rates, inflation and longevity.
Understanding your cash flow needs and how you will generate cash in retirement is an important step when planning for retirement. Consider the following:
You should factor in these considerations when making financial plans. The last thing you want is to run out of money or fall short of your retirement needs.
A financial adviser can help you align your investments with your goals and help you throughout the investment process. Fisher Investments UK may be able to review your current investments and options and advise on their suitability for your financial goals and objectives. Contact us today to learn more.
*The contents of this document should not be construed as tax advice. Please contact your tax professional.