Friends Provident - Investment bonds - funding a retirement income

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Investment bonds - funding a retirement income

By Mark Avant, Senior Technical Consultant

There are many types of pension arrangement, all designed to provide an income in retirement. These include personal pensions, occupational pensions, stakeholder, SIPPs, SSASs, RACs and more. For all these types of registered pension schemes, the taxation treatment is mostly very appealing – tax relief on contributions (at marginal rates of income tax), tax-exempt funds and tax-free lump sums. On the downside, pension annuities are taxable, access to funds is limited and the rules and regulations are ever-changing and frequently confusing.

Those who are looking for alternative methods of creating a tax efficient retirement income could consider the merits of investment bonds. Such individuals may already be making the maximum level of pension contributions eligible for tax relief or could be simply looking for greater flexibility and access to funds. The restrictions on contribution relief, effective from April 2011, will surely increase the focus on non-pension investments for those on high incomes.

A bond premium does not qualify for tax relief and life funds are internally taxed but, even so, a bond does have the following attractions for retirement planning:

  • An investment can grow in a tax privileged life fund. All income and growth within a fund is likely to be taxed at a rate significantly less than 20% (actual rates vary according to the asset mix of the fund). This is particularly attractive to higher or additional rate taxpayers who would pay tax, at their marginal rates, on gross income from other sources such as dividends and within collective investments (OEICs and investment trusts).

  • Money can be extracted from a bond at any time, whether pre or post-retirement. Regular or ad hoc withdrawals can be taken, of up to 5% of the original investment each year for up to 20 years, without triggering an immediate tax liability. Unused 5% amounts may be cumulated and offset against future withdrawals. Compare this to the restrictions, fixed nature and taxation of a pension annuity.

  • The full value of a bond will be available, on the policyholder’s death, for distribution to beneficiaries of their estate although there would be a liability for any income tax payable on a chargeable event. The bond value may also increase the estate’s inheritance tax liability or even create a liability that would not otherwise exist.

  • The policyholder can make an inheritance tax effective gift of their bond into trust, at any time. This could be an option if they are certain that they no longer need personal access to the bond (perhaps following an inheritance or other change in financial circumstances).

  • A bond investment can be made on a joint life second death basis, offering greater flexibility. Following a first death, the survivor has many options including to continue taking any fixed periodic withdrawals, taking irregular amounts, encashing the bond to release a greater sum, gifting it to a family member and placing it under trust.

A formal pension arrangement should always be the first consideration when planning for retirement. Those looking outside of the pension arena should be aware that a bond has certain appeal as a retirement planning investment. A bond can be both flexible and tax efficient and is not bound by the strict rules and regulations that apply to pensions.