Investment bonds are designed to produce medium- to long-term capital growth, but can also be used to give you an income. They also include some life cover. There are other types of investment that have ‘bond’ in their name (such as guaranteed bonds, offshore bonds and corporate bonds), but these are very different. You pay a lump sum to a life assurance company and this is invested for you until you cash it in or die.
Investment bonds are not designed to run for a specific length of time but they should be thought of as medium- to long-term investments, and you’ll often need to invest your money for at least five years. There will usually be a charge if you cash in the bond during the first few years.
The bond includes a small amount of life assurance and, on death, will pay out slightly more than the value of the fund. Some investment bonds offer a guarantee that you won’t get back less than your original investment, but this will cost you more in charges.
You can usually choose from a range of funds which can invest in, for example UK and overseas shares, fixed interest securities, property and cash. They can also offer a way of investing in funds managed by other companies, but this may lead to higher charges.
Investment risk can never be eliminated but it is possible to reduce the ups and downs of the stock market by choosing a range of funds to help you avoid putting all your eggs in one basket. Different investment funds behave in different ways and are subject to different risks. Putting your money in a range of different investment funds can help reduce the loss, should one or more of them fall.
You can usually switch between funds. Some switches may be free, but you may be charged if you want to switch funds frequently. Any investment growth at the time of a fund switch is not taxable.
Any growth in investment bonds is subject to income tax. The investment will pay tax automatically while it is running so, if you are a:
non-taxpayer – you will not have to pay any further income tax but you cannot reclaim any tax;
basic-rate taxpayer – you will not normally have to pay any further income tax; and
higher-rate taxpayer (or close to being one) – if you withdraw more than 5 per cent of the original investment amount in a year or you have made a profit when you cash in the investment, you may be liable for more income tax.
Depending on your circumstances, the overall amount of tax you pay on investment bonds may be higher than on other investments (like a unit trust, for instance). But there may be other reasons to prefer an investment bond. Or you may want to set up the investment within a trust as part of your inheritance tax planning (but note that you normally lose access to at least some of your money if you do this).
You can usually take out some or all of your money whenever you wish but there may be a charge if you take money out in the early years.
You can normally withdraw up to 5 per cent of the original investment amount each year without any immediate income tax liability. The life assurance company can pay regular withdrawals to you automatically. These withdrawals can therefore provide you with regular payments, with income tax deferred, for up to 20 years.