Seven things you should know about investment bonds
Peter McGahan, managing director of IFA Worldwide Financial Planning picks out seven key things you might not know about investment bonds.
1. An investment bond is simply a tax wrapper just as an ISA is. You can have a property fund inside an investment bond and the same property fund inside an ISA.
The property fund inside the investment bond will grow and pay basic rate tax as it grows, with the potential to pay higher rate tax at a later stage or even the loss of age allowance for those over 65. An ISA grows free of tax. So within an investment bond, the property fund will underperform.
2. The second most popular investment for most people, ahead of an investment bond would be a collective such as a unit trust which has a tax free capital gain each year of £10,100. So if you have £100,000 invested and it grows at 10% you would have no tax on the gain.
Most investments would be less than £100,000 so you would therefore expect most investors to have tax free growth on their investments. If investors took the growth each year they could roll that straight into an ISA. Remember this is per person.
3. Investment bonds have disguised charges. They have an 'extra allocation' rate which effectively hides the upfront charges but takes them out over a period of five years or on earlier encashment. So either way they take back the extra you are given along with their normal hefty charges.
4. They are sold as a plan that gives you a 5% tax free income. An investment bond is often understood as a plan that will give you this income and as long as you encash and restart the plan before year twenty, there will be no tax to pay and you can then start a new twenty years of tax free money.
"It's nonsense," says McGahan. "With an investment bond you can take your money back (5% over 20 years). Big deal, where is the tax break there? There isn't one."
5. An ISA typically pays a financial adviser 3% commission whereas an investment bond pays 7% or 8% in many instances.
6. The choice of funds you can invest into within an investment bond are normally more restrictive than other options, such as a fund supermarket or fund platform where all the best funds are freely available. Furthermore, if you invest via a wrap account, you will be able to access most funds for the lowest price and that is often close to zero.
Unlike investment bonds, which the financial adviser visits every five years and puts you through a new set of charges, there is no need for those product fees on a wrap so you can wave goodbye to them forever.
7. Mirror funds might be a technical term but they are indeed a puzzler. Inside an investment bond you may believe you are buying the pure investment fund but in reality you are not - you are actually buying a disguised version of it.
Over a three year period, McGahan assessed Fidelity UK Special Situations which returned a healthy 54.7%, but over the same period the AIG Fidelity UK Special Situations (a mirrored version of the real fund) only delivered 40.17%, meaning investors in the Fidelity special situations fund gained 36% more over the same period.
"These mirrored versions are easily recognised as they normally have the name of the insurance company in front of the fund as per the AIG example."