Investment bonds are usually classed as a single premium ‘life insurance’ policy because a portion of your ‘life insurance’ policy can be paid out upon death, but they are really an investment product.
Investment bonds mainly fall into two categories, onshore and offshore. The main difference is their tax treatment. In high-level terms, those onshore are subject to UK corporation tax, which is offset by your provider, while offshore bonds are issued from outside the UK and the returns roll up gross of tax in the funds, apart from withholding tax, as described below. Offshore bonds may also offer a wider choice of funds.
UK Investment bonds are non-income producing investments and so have a different tax treatment from other UK based investments. This can provide valuable tax planning opportunities for individuals.
The funds underlying the bond are subject to UK life fund taxation, meaning that you are treated as having paid Income Tax at the basic rate on the amount of your gain. This notional tax is not repayable in any circumstances. You will have no liability to Capital Gains Tax or basic rate Income Tax on bond gains.
Offshore is a common term that is used to describe a range of locations where companies could offer customers growth on their funds that is largely free from tax.
With an onshore bond tax is payable on gains made by the underlying investment, whereas with an offshore bond no income or Capital Gains Tax is payable on the underlying investment. The lack of tax on an offshore bond means that potentially it could grow faster than one that is onshore, although this isn't guaranteed. But, note that you will pay income tax on any gain at your highest marginal tax rate. This is because on an offshore bond you are not treated as having paid basic rate tax on any gain.
There are many issues which should be considered when deciding whether to invest in onshore or offshore bonds. Any tax advantages may be small depending on the actual effective tax rates applying to the onshore policyholder and the underlying fund. This may be further offset by a higher charging structure applying offshore.
However, there are obvious scenarios when offshore bonds may be regarded as an appropriate investment for UK resident investors:
An investment bond can potentially be a tax-efficient way of holding a range of investment funds in one place.
You can withdraw up to 5% each year of the amount you have paid into your bond without paying any immediate tax on it. This allowance is cumulative so any unused part of this 5% limit can be carried forward to future years (although the total cannot be greater than 100% of the amount paid in).
However, if you decide to take more than 5% per year and/or you cash in your entire bond, you may be subject to Income Tax.