A Guide to Investment Bond Taxation

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A Guide to Investment Bond Taxation

If you find yourself reading more on personal finance and investing in your future, whether you’re a beginner or advanced, then you probably would’ve heard of investment bonds by now.

However, we often receive questions and see a common question being brought up time and time again “Do you pay tax on your investment bonds? and if so, “How does it all work?” Well, in this article, we’re looking to break down the core details of what you’re going to need to know.

Therefore, if you’re looking to begin funding your investment bonds, you may want to consider reading the important parts of this to understand what you’re getting yourself into and how to deal with taxation when the time comes so you’re fully prepared; carry on reading to learn the ins and outs.

 

Key Takeaways

  • You can invest in many types of investment bonds but almost all have the same taxation requirements
  • You will only begin paying tax on your investment bond if you trigger a chargeable event
  • If you’re a company, the tax-chargeable events DO NOT apply (tax-free)
  • Bonds are often structured as a series of segments, which allows for greater control over the taxation of gains
  • You must make sure that any chargeable event gain is given to the correct person
  • The five types of chargeable events are: full surrender, part surrender, maturity, assignments, and death
  • Top-slicing relief can reduce the tax on gains that take an individual into a higher or additional tax bracket
  • If you’re in the UK, chargeable event gains on bonds are NOT liable to basic rate tax.

 

What is an Investment Bond?

An investment bond is a financial product that allows you to invest a certain amount of money for a fixed period of time, typically 5 to 10 years. It is a type of bond that is issued by companies, governments, or other organisations to raise capital for their operations. Unlike stocks, which represent ownership in a company, investment bonds are a form of debt.

This means that investors are essentially lending money to the bond issuer and in return, they receive regular interest payments at a fixed rate. The initial investment amount is typically repaid at the end of the bond’s term.

Investment bonds are considered a relatively low-risk investment option and can provide a steady stream of income for investors. Overall, think of it as lending your money to someone with the expectation of getting more back over time.

 

Different Types of Investment Bonds

There are several kinds of investment bonds available, each with their own unique features and potential benefits. Here are the different types:

 

  • Corporate bonds – issued by companies and offer a higher yield but also carry a higher level of risk.
  • Government bonds – a safer investment option as they are backed by the government’s credit.
  • Municipal bonds – are issued by local governments and offer tax advantages.
  • High-yield bonds (also known as junk bonds) – offer a higher yield in exchange for a higher level of risk.

 

[Worth mentioning—>] These are just a few of the many types of investment bonds you can look at investing in, but it is important to carefully consider the different types of investment bonds and their associated risks before making any final investment decisions.

 

What Are the Chargeable Events For Paying Investment Bond Taxation?

Chargeable events for paying investment bond taxation refer to specific events that trigger a tax liability for individuals who hold investment bonds. These events can include the following:

 

Full Surrender

With full surrender, when you cash in a bond, any profit it’s earned (called the ‘chargeable gain’) gets taxed as income. The calculation includes the initial investment plus any extra money put in and subtracts any previous gains or withdrawals made from the plan.

 

Part Surrender

On the other hand, with part surrender, without becoming subject to personal tax liability, up to 5% of the total premiums paid can be withdrawn. Any unused 5% tax deferred allowance can be carried forward, meaning you can delay tax payments, but it will start on the bond’s start date or its anniversary and any surplus is calculated on the policy year’s last day.

 

Maturity

With your investment bond, if applicable and held to maturity (whether it be 5, 10, or 20 years), you will receive the full payment of the bond’s final value, plus the growth of the bond too. To calculate the chargeable gain, you can use the cash-in value at the maturity date or the guaranteed maturity value. Whichever is higher, you should choose.

 

Assignments

Assignments are essentially where you gift someone an investment bond or the person receives one from an adult beneficiary. In the likelihood of this happening, assignments don’t always result in a chargeable event. However, the new owner will be treated as if they have always owned the bond, even if they haven’t for new income tax purposes.

 

Death

For death, the taxable gain is figured out similarly to when the bond is cashed in completely (fully surrendered). Yet, if the bondholder passes away, the value considered is what the bond is worth at that time, not what’s actually paid out.

However, this will be looked at for tax purposes in the tax year when the last person on the bond dies. If there are still others named on the bond after the holder dies, no tax is due. Whereas, once the last person passes away, the bond ends, and any gains made are then taxed.

 

Who Pays the Tax on the Investment Bond?

The tax associated with investment bonds is only paid if one of the above chargeable events occurs. This means that investors don’t need to worry about paying any tax on their investment unless they feel as though one of the above chargeable events may happen. In that case, the owner of the bond at the time will be liable to pay the income tax.

 

How to Calculate Your Investment Bond Tax

Investment bonds are a popular option for individuals looking to save for the future, but it’s important to understand how they are taxed if you find yourself in one of the chargeable events. To calculate tax, there are two ways this can go. If you have an onshore bond, it’ll be different than an offshore bond; let’s take a look at the two different processes:

 

Onshore Bond Tax Calculation

The tax on onshore bonds is computed by spreading the gain across the years of ownership. Top-slicing relief can be applied, which divides the gain by the number of years to potentially lower the tax rate.

This tax-efficient relief helps make the tax charge more manageable for investors, providing a fairer tax outcome, but you’re also taxed as the top part of income, so after dividend income.

A drafted-up example:

 

Year Investment Growth (£) Total Investment (£) Cumulative Gain (£) Taxable Gain (£) Tax Rate (%) Tax Due (£)
1 £1,000 £10,000 £1,000 £1,000 20% £200
2 £800 £10,800 £1,800 £800 20% £160
3 £1,200 £12,000 £3,000 £1,200 20% £240
4 £600 £12,600 £3,600 £600 20% £120
5 £1,500 £14,100 £5,100 £1,500 20% £300

 

    • Each year, the investment bond grows by a certain amount
    • The cumulative gain is the total growth of the investment over the years
    • The taxable gain is the portion of the cumulative gain that is subject to tax
    • The tax rate is typically 20% for onshore investment bonds in the UK
    • Tax due is calculated by applying the tax rate to the taxable gain

 

Offshore Bond Tax Calculation

Offshore bond tax calculation resembles onshore bonds but with varying top-slicing relief rules. Gains are still spread over ownership years, but nuances exist, meaning you are taxed after earned income but before dividends. Your gains are taxed at 20%, 40% or 45% unless you have any of the following allowances:

 

      • A maximum starting for savings rate of up to £5000
      • Personal allowance of up to £12,750 and not going above this number
      • You are a basic rate taxpayer and can earn up to £1,000 a year

 

We hope this summarises everything you need to know in a simplified manner, but if you’re stuck on a specific topic or want to know more advanced ways of calculating your own situation, reach out to us here at Compare Investments and we’ll gladly help you make the right decision!

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