We are reviewing the advice given in relation to investment bonds:
I was advised by a financial adviser to choose an investment bond and he mentioned that 103% of my money would be invested. He said it was the cheapest way to invest and it was tax-free income.
Our advice on the above:
An investment bond or insurance bond as they are often called is a method used by many investors to invest their cash. There are three ways to measure them: charges, tax, and performance.
The charges are often hidden or at best disguised. The allocation rate you mentioned above is a lure and if you have ever used a lure when fishing you will realise there are a number of sharp hooks which apparently don’t hurt the fish. Instead of taking an upfront charge of x% you will be charged this fee over a period of 5 years typically.
Don’t believe that’s a bargain as the charge is reasonably steep. Ask your adviser if you took the cash out the day after investing what the charge would be and you’ll see the true impact of the charges.
The tax is not advantageous and you’ll see that the tax break you are being offered is 5% of your investment as an income per year over 20 years (that’s just your money back and is hardly a break). What you also don’t see is that the fund is disadvantaged by paying tax as it grows and you can’t reclaim that. That’s more of a brake than a break. There are other tax problems such as when an over 65 year old encashes the investment, the gain is added to their income. That could cost them to lose their age allowance and an immediate tax charge of up to £524.70.
If you are encashing the investment consider also that the gain will have to be calculated to assess if further tax is payable. The rate could be a further 18% if not planned correctly.
From a performance point of view it’s worth pointing out that most insurance bonds have a limited range of funds, which are at the very best average. Some companies realise this and offer a large range of funds. One I looked at above had over 150 funds to choose from, but when I researched the actual performance, not one of the funds was on our buy list. They were simply a range of cheap funds.
The more preferable options to consider are an ISA or unit trust. An ISA allows for the investments inside it to grow free of capital gains tax but you are limited to £11,280 (from April 2012) per person. A unit trust has numerous breaks. You are allowed a capital gains allowance each year of £10,600. This means that you can access £10,600 each year without any liability to capital gains tax. If the gain is more than that you can delay it for a year and use next year’s allowance. Remember that the allowance is per person and both husband and wife have one. There is also the added advantage of taper relief to reduce the gain as well as previous indexation relief. Moreover on death the unit trust’s gain is wiped out so there will be no further tax to pay.
Using the annual CGT allowance, you could take 5% per year per couple from £352,000, which would be completely tax-free.
Lastly a unit trust allows you to offset any gains or losses you have made elsewhere. If you have made a gain on your 2nd property and your unit trust had gone down you could simply encash both in the same year and offset the loss against the gain.
An investment bond would not give you that break at all.
I hope it wouldn’t be a consideration of the adviser but you will find that some insurance bonds do pay up to 7.5% commission whereas a unit trust and ISA typically pay 3%. Your adviser will have to display this to you anyway.
Worldwide’s score: 2 out of 10