Profits of Bonds

Are you currently looking to receive an additional income from your capital? Well, there is a product that lets you take an income without any immediate worry about tax, which lets you control how much income you receive, and which grows steadily but is less likely to immediatly fall in value if the stock market plunges. Where can you find such an investment? Look no further than a with-profit bond.

No more peaks and troughs
With-profit bonds invest in insurance company with-profit funds. Typically, the minimum investment accepted is £5,000. The tax status of qualifying bonds effectively means that no capital gains tax is payable on the proceeds. If you are a basic-rate taxpayer, there is no further tax to pay unless any gains that you make take you into the higher rate tax bracket.

With-profit funds generally invest in a mixed portfolio. Gains from the fund are shared out to investors as annual bonuses. Each year, a life company will declare the bonus to be paid out to its with-profit fund holders and, once these bonuses have been declared, the life company cannot take them back. There is no guarantee that future annual bonuses will be paid.

As well as annual bonuses, you may also receive elements of what is called the 'terminal bonus'. With-profit bonds don't have a fixed term, so elements of the terminal bonus are either paid throughout the term or when the bond is cashed in - the approach varies. However, this terminal bonus is not guaranteed and its payment and size depends on the performance of the bond's underlying funds during its term.

A flexible income
One of the attractions of with-profit bonds is that they allow you to decide how much income to take. Most modern with-profit bonds offer flexibility of income payments. Each year, you can withdraw up to 5% of your original lump sum with no immediate liability to tax, and you can keep doing this for 20 years - or until you have effectively withdrawn all your original capital. Usually, you have the option to have your income paid automatically into your bank account, and you can take this payment either monthly or quarterly.

The great advantage of with-profit bonds is that, if you withdraw less than 5% in a year, you can make up for it later.

Taxing matters
As with all single-premium life insurance investments, the fund itself is subject to tax. With-profit bonds are considered 'tax paid'. All proceeds are deemed to have basic-rate tax already deducted, so lower and basic-rate taxpayers have no further tax liability.

A tax liability falls on you only if you are a higher-rate taxpayer at the point you take money out. When you finally encash your bond or exceed the 5% allowances, the profit made from your bond is averaged over the life of the bond and added to the rest of your annual income for that year. This means that if your total income falls into the higher-rate tax bracket, tax might be payable. This process is known as 'top-slicing' and is quite a complicated calculation. We can explain this in more detail when appropriate to your own situation.

The main purpose for deferring the tax if you are a higher-rate taxpayer is so that, when you encash the bond, you do this when you are a basic-rate taxpayer in order to redue the tax paid.