How does the Autumn statement affect the Investment Bonds vs Collectives debate?
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Factors to consider when deciding how to invest capital most tax efficiently, once the ‘tax no brainers’ have been exhausted
After the ‘excitement’ of the Autumn Statement in November 2022, and everything that preceded it, where do the various tax changes/reversals leave the ‘bonds v collectives’ decision? We asked Tony Wickenden of Technical Connection to provide his thoughts in the following article which is based on a bulletin published on the Technical Connection Techlink Professional platform.
We know there’s been no diminution to the tax appeal of the so called “no brainers” of pensions and ISAs. Investors and the financial planning community no doubt breathed a collective (no pun intended) sigh of relief; and VCTs and EIS survived unscathed too, with SEIS even gaining a few enhancements.
So, once we look beyond this, do investment bonds or collectives hold more appeal? And if the former, onshore bonds or offshore bonds?
We believe the answer lies in whichever investments underpin the bond or collective – they are freely available in both structures – and the current and expected future tax circumstances of the investor. Of course, the impact of charges and how they are deducted and accounted for at fund level also need to be factored into decision making. However, for the purposes of this article we will concentrate purely on the tax differences.
Let’s remind ourselves of the key “tax factors” underpinning the bonds v collectives decision making process. Once the revision is over, we’ll review whether the changes announced in the Autumn Statement (and the reversals of earlier tax policy) make any difference to decision making.
Collectives:
Dividends: Equity funds (invested at least 40% in equities).
Dividend allowance currently £2,000 reducing to £1,000 in 2023/24 and £500 in 2024/25.
Beyond the allowance: dividends taxed at 8.75% (BR), 33.75% (HR) and 39.35% (AR).
Interest Distributions: Fixed interest funds (invested more than 60% in fixed interest and/or cash deposits).
Personal allowance and higher rate tax threshold frozen until end of 2027/28.
Additional rate threshold reduced to £125,140 from 2023/24 and frozen until April 2028 (thereby reducing the threshold for the Personal Savings Allowance, which is unavailable for additional rate taxpayers).
Capital Gains:
Annual exemption at £12,300 for 2022/23 but dropping to £6,000 for 2023/24 and £3,000 for 2024/25 and frozen thereafter. Trusts suffer the same proportionate reductions.
Capital gains beyond the exemption remain generally taxed at 10% below higher rate and 20% within the higher/additional rate. Note that although capital gains are taxed as the top slice of income, they cannot be offset by any unused personal allowance, a factor that becomes more relevant with the lowered annual exemption.
Tax free “rebasing” still takes place on death, but lifetime transfers are normally taxable disposals for CGT purposes.
Onshore Investment Bonds:
Zero tax on dividends at policyholder fund level (without limit) remains (but withholding tax might apply).
Non dividend income remains taxed at 20% at policyholder level.
Top slicing relief (with its tax management benefits) continues.
5% tax deferred withdrawal rules continue.
Basic rate tax credit in determining policyholder tax on realised chargeable gains continue.
Lifetime transfers (gifts) by way of assignment are not income taxable events.
Offshore Investment Bonds:
Zero tax on all income and capital gains at life fund level (but withholding tax might apply).
Top slicing remains available.
5% withdrawal rules remain.
Personal savings allowance, personal allowance and zero starting rate band remain available.
Chargeable gains (not covered by the PA, PSA, SRB) taxed at appropriate policyholder rate with no basic rate credit.
Lifetime transfers (gifts) by way of assignment are not income taxable events.
So, now we have refreshed our knowledge, where does this leave us?
The tax fundamentals applying to collectives and both types of bonds have not changed. We would also suggest that the essence of decision making hasn’t altered either. However, the many tweaks to personal taxation do matter, specifically the following five aspects:
- The continuation and extension to April 2028 of the frozen personal allowance and higher rate tax threshold;
- The reduced threshold for additional rate tax from 2023/24 to April 2028;
- The continuation of the higher rates of dividend taxation introduced in 2022/23;
- The reduction in the dividends tax free allowance from 2023/24 and again in 2024/25; and;
- The materially reduced CGT annual exemption from 2023/24 and again in 2024/25 with no indexation thereafter.
Together, these changes will impact on the level at which bonds should be considered as a tax deferment/tax management vehicle instead of unwrapped collectives.
To the extent that income and capital gains from collectives are likely to be tax free, (all other things being equal), there is no tax reason for a bond. This will remain the case in future years, but with the dividend allowance and the CGT exemption falling so dramatically over the next couple of years, we believe that consideration of these tax-free thresholds and the possible role for investment bonds will become relevant to more taxpayers for the first time.
Beyond the thresholds, let’s consider income first.
Tax freedom will still be possible in 2023/24 and 2024/5 (and beyond) for dividends from an equity fund to the extent that they fall within the reduced allowance of £1,000 or £500 respectively. However, the halving of the dividend allowance in 2023/24, and it is halving again in 2024/25, means the value of an investment that could be made (on the basis that dividends will be tax free) will be 25% of what it would be this tax year.
Based on the current FTSE All-Share Yield (approximately 3.6%), the value of a shareholding needed to exceed the relevant tax year’s dividend allowance is:
- £55,600 in 2022/23;
- £27,800 in 2023/24; and
- £13,900 in 2024/25
These figures can be doubled for married couples and civil partners with joint holdings. Of course, as values change so do yields and actual dividends vary with disposable profits and reinvestment/distribution decisions.
A similar dynamic applies to tax free capital gains, with the annual exemption falling by over 50% in 2023/24 and then halving (and freezing) in 2024/25.
In theory the bar above which investment bonds could be considered for tax efficiency is likely to fall by around 50% in 2023/24 and by a further 50% in 2025/6. In other words, the entry point for considering bonds will be materially lower for all taxpayers. The extent to which that “threshold” is lowered in any particular case will of course depend on the extent to which projected growth in the value of an investment will be driven by dividends, savings income, and capital gains. Once the “bond consideration threshold” is crossed, the factors to consider determining the appropriate product will be much as they are now.
Both the onshore and offshore bond represent tax efficient locations for accumulating otherwise taxable dividends, as in both structures the dividends will accumulate tax free and without limit. Of course, though, there is no basic rate credit for eventually realised gains under an offshore bond that are subject to tax in the UK.
Capital gains will be taxed, or reserved for, at a maximum rate of 20% in an onshore bond. There will also be a 20% tax born on non-dividend income generated by the UK life fund. There will however be no tax on capital gains or non-dividend income inside an offshore bond offshore bond. This means that all other things being equal, the offshore bond will deliver the best returns pre personal tax, as it’s not being diminished by any internal life company tax. But on encashment, there will be no basic rate credit and in many cases a greater tax liability than under an onshore bond except to the extent that a personal allowance, personal savings allowance or zero starting band can be used, or tax can otherwise be avoided altogether on encashment.
The dividend allowance is irrelevant when comparing the methods of holding a fund invested over 60% in fixed interest/cash investments. However, the frozen thresholds and reduced additional rate tax threshold (with its knock-on effect to the personal savings allowance) may be relevant; and of course, there’s also the reduced CGT annual exemption.
The marginal overall effective tax rates on income and gains, beyond the relevant allowances and exemptions is summarised in the following table.
| Marginal Income Tax Rate | Nil % | Basic % | Higher % | Additional % |
| Equity dividends: | ||||
| Collective fund | 0.00 | 8.75 | 33.75 | 39.35 |
| Onshore bond | 0.00 | 0.00 | 20.00 | 25.00 |
| Offshore bond | 0.00 | 20.00 | 40.00 | 45.00 |
| Equity gains: | ||||
| Collective fund | 10.00 | 10.00 | 20.00 | 20.00 |
| Onshore Bond† | 20.00 | 20.00 | 36.00 | 40.00 |
| Offshore bond | 0.00 | 20.00 | 40.00 | 45.00 |
| Fixed Interest distributions: | ||||
| Collective fund | 0.00 | 20.00 | 40.00 | 45.00 |
| Onshore bond | 20.00 | 20.00 | 36.00 | 40.00 |
| Offshore bond | 0.00 | 20.00 | 40.00 | 45.00 |
| Fixed Interest gains: | ||||
| Collective fund | 10.00 | 10.00 | 20.00 | 20.00 |
| Onshore bond* | 20.00 | 20.00 | 36.00 | 40.00 |
| Offshore bond | 0.00 | 20.00 | 40.00 | 45.00 |
† Assumes full 20% tax rate applied by the life company on gains. Actual reserving rate for collective-based life funds may be marginally lower to reflect deemed annual realisation with tax spread over seven years.
* Loan relationship rules apply within an onshore bond
Although it does not change the mathematics, there’s one other administrative tax factor that we need to bear in mind: self-assessment returns.
When the Office of Tax Simplification (OTS) looked at Capital Gains Tax (CGT) reform in its first report, an HMRC graph (based on a 2021/22 projection for individuals only) suggested the following:
- A £3,000 exemption would drag about 225,000 people into self-assessment for the first time: and
- Around 110,000 people would be newly required to complete the CGT section of their return.
As anyone who has completed the CGT supplementary pages (SA 108) will know, not only do the gains have to be set out in significant detail, HMRC also require computations sheets for each asset disposal (see example on page 11 of the CGT Notes).
The HMRC TIIN on the exemption reduction, published four days after the Autumn Statement (no comment), had some rather different estimates. It says ‘…it is estimated that for the year 2023 to 2024 around 500,000 individuals and trusts per year could be affected, increasing on a cumulative basis to 570,000 in 2024 to 2025. Of this group, by 2024 to 2025 it is estimated that 260,000 individuals and trusts will be brought into the scope of CGT for the first-time.’ A comparison with the earlier OTS report numbers is complicated by the fact of another CGT change, not announced in the Budget.
The current rule, for those that have complete a self-assessment tax return, that requires SA 108 to be completed if proceeds exceed four times the annual exemption, regardless of whether any CGT is due, will be amended from 2023/24 to a new cash threshold of £50,000, i.e., much in line with today’s current figure of £49,200.
A similar reporting issue could arise because of the cuts to the dividend allowance. Again a delayed TIIN was issued on this subject. It said ‘It is estimated that (the dividend allowance cuts) will affect 3,235,000 individuals in the year 2023 to 2024 and 4,405,000 individuals in the year 2024 to 2025. Around 46% of those with taxable dividend income will be unaffected by this measure in the year 2023 to 2024, falling to 27% in the year 2024 to 2025.’
The current HMRC stance is that there is no need to complete a self-assessment form if dividend income does not exceed £10,000, but there is a requirement to contact HMRC if the dividend allowance is exceeded to arrange payment of the tax due. For some investors, a bond that incurs marginally more tax than a collective investment but does not require contacting HMRC, filing a tax return and/or CGT pages completed may be the preferred overall option.
In conclusion, it remains the case that, if the income and capital gains from the underlying investments are likely to be tax free from unwrapped collectives, then the collective will “win” and there is no need to consider a bond for tax deferment.
However, from tax year 2023/24, the point at which this “win” ceases will be lower. So, investment bonds (onshore or offshore as appropriate) need to be considered at a correspondingly lower monetary investment entry point. This will continue to require financial advisers to consider a wide variety of factors, including the individual investor’s current and expected future tax position, the balance between income and capital gains on the underlying funds – see table above – and the tax reporting already undertaken by the investor, advice will continue to be necessary.