With Profit Bond

What is it?

A With Profits Bond is an investment of a capital sum into a vehicle that provides an investor with the potential for capital growth and an income if required.  It is intended to be medium to long term investment.

Who are they for?

A Profits Bond is aimed at investors who wish to invest in a tax efficient way to achieve medium to long term growth at low to medium risk.

How does it work?

A capital amount is invested into a With Profits fund.  Profits are added to the investment by adding bonuses to the investment.  Bonuses are declared out of the investment earnings and profits.  There are two types of bonus – an annual bonus and a terminal bonus, which may be added when you cash in or make withdrawals from the investment.  Adding bonuses in this way helps smooth out the fluctuations in the value of the underlying assets.  The level of bonuses is not guaranteed.

The With Profits Fund

The underlying investments of a With Profits fund include UK and overseas equities, fixed interest securities, corporate bonds, gilts, property and cash.  The amount of equity content ranges from 30% up to 75% of the fund depending on the product provider and this provides for the main capital growth of the fund.

Tax situation

A With Profits Bond is not a tax-free investment as the underlying investments in the With Profits Fund suffer Income and Corporation tax at basic rate.  These taxes are paid by the fund and therefore there us no further tax liability to Income tax or Capital Gains tax for basic rate taxpayers.

For higher rate taxpayers (or those on the threshold) as long as the total amount of income and/or withdrawals made each year for the first 20 years is restricted to 5% of the original investment, a further tax liability can be avoided.  Any unused 5% ‘allowance’ can be carried forward to future years.

A withdrawal over the 5% p.a. allowance or on full encashment is called a chargeable event.

Any tax liability on withdrawals is calculated on the amount withdrawn in excess of the accumulated 5% allowances.  This amount is added to the investor’s taxable income.

‘Top Slicing’ may help to reduce this tax liability for basic rate taxpayers.  This is whereby the excess is divided by the number of complete years that the bond has been held since the last chargeable event.  The profit slice is then added to the investor’s taxable income.  If the profit slice falls into the higher rate tax bracket it is taxable at the higher rate minus the basic rate (i.e. currently 20%).  The total tax due is then calculated by multiplying this amount by the number of years since the last chargeable event.

Full encashment of the bond can be deferred until the investor’s income is lower to help further avoid a tax liability.

The death of a single bondholder or the last survivor of a joint bond will be classed by the Inland Revenue as a chargeable event.  This could lead to a tax charge for higher rate taxpayers and for a basic rate taxpayer becoming a higher rate tax payer due to ‘top slicing’