Types of Investment Bonds

Types of Investment Bond

There are two major types of investment bond:

Coupon Bonds: This is where investors pay the full value of the bond while purchasing coupon bonds. Here, as an investor, you will receive periodic investment payments throughout the lifespan of the bond, and once the bond matures, you get paid the face value of the bond.

Zero-coupon Bonds: Investing in this type of bond means that you do not receive periodic payments at all, as these bonds are bought at discounted prices. On bond maturity, you receive the original price of the bond.

How Bonds Work

If, after looking at the previous section, you feel like this is the right type of investment for you, then we need to look at how investment bonds work:

• Most bonds last for a lifetime, with no minimum term of use. If you want to suddenly back out, there are surrender penalties, especially in the early years.
• As an investor, you have two choices of funds to invest your money into. This is a choice left strictly to you and your financial adviser.
• At death, or the end of the investment duration, a large sum of money will be paid out to the investor or the guarantor to the investor. The amount of money paid depends on the terms and conditions of the bond as well as the performance of the investment.
• Some investment bonds guarantee your returns as well as your capital. The use of a counterparty is what ensures your capital and returns most of the time.

How the Money is Invested

Investment bonds give you a choice of two types of funds:

• Profits
• Unit-linked

Both of these investment types have the same tax rules, where the tax is paid on the income accumulated in the fund by the insurer as well as the growth.

Risks and Returns

Every investment has its risks and returns; ones which you set before the payment of the money:

• Some investments guarantee that you will not get back less than you initially invested.
• Because some bonds have an element of life insurance, your investment bond policy might pay slightly more than the value of the fund in the event that you die during the term of the bond.
• Whenever you choose a bond that allows you to invest in different types of investment funds and switch funds, you might weather the problems of the market better with diverse investments.

Access to Your Money

In this section, we are going to be looking at another vital aspect of investments, which is access to your money. Here are some things you need to know:

• You can withdraw some of your money, or even all of it, whenever you need to, but you should know that you might have to pay a surrender penalty, especially if you want to make a withdrawal within the first few years. You might also have to pay a tax charge in the withdrawal process. 
• Investment bonds allow you to make regular withdrawals yearly with a specified amount already set. Withdrawals of up to 5% of the amount you invested can be made annually without triggering any tax liability. However, the tax is only deferred when the bond is cashed in. Also, withdrawals will be added to any profit made and taxed as income in that tax year.
• Finally, you also have to make sure that you look at the policy conditions to fully understand what charges might apply to partial or full withdrawals.

Charges

Here are some of the things you need to know about investment bond charges:

• Whenever you take out the bond, there might be charges to pay. This all depends on your investment type.
• If you have to choose a bond that guarantees that you do not lose money irrespective of the way things turn out, you might have to pay some extra charges as well.
• If you have to switch between insurer’s investment funds, it is free, but you might be charged if you switch often.
• You might also have to pay a charge if you would like to cash in on your investment within the first few years. 

Insurers often offer a variety of charging structures to choose from. The most important thing you have to do is make sure that you select a good charging structure, and that you understand all that it takes.

How Safe Are They?

Investment bonds are very safe and secure, except in a situation where your insurance company goes bankrupt. One thing you have to know is that you cannot, under any circumstances, claim any compensation just because the value of your investment falls.

So, depending on what investment bond you want to purchase, always seek the help of your financial adviser to help you weigh the risk attached.

Tax on Investment Bonds

All income and gains earned in an investment bond are paid directly of the investment bond and are taxed at 20%. You are also allowed a withdrawal of up to 5% a year for about 20 years without experiencing an additional tax charge. If you do not use your 5% allowance in a given year, the allowance is moved to the next year. The good thing about this is that it accumulates as you do not make use of it. If you do not make a withdrawal in the first year, you could draw up an accumulated 10% the next year without incurring a tax liability.

Therefore, if a higher-rate tax payer, where you pay almost 50% income tax each year, an investment bond can help you reduce the cost on your income tax. However, your tax bill does not just disappear totally; instead, it is delayed, and any extra tax due will be payable at the time when your bond matures, or when you cash in the bond.

All gains made on your capital are treated as income at this point. Even though at this point, a tax of 20% has already been deducted, you might have an additional tax bill if your profit pushes your income over the additional tax threshold in the year that the bonds mature.

This is something you can avoid by using a method called Top slicing. Top Slicing simply means dividing your profit over the lifespan of the bond by the number of years the bond has been held – this must include withdrawal time as well.

If, when you add the resulting figure to your income tax, you get a figure below your higher-rate tax threshold, there is no additional tax to be paid. On the other hand, if the profit moves over the higher-rate tax threshold for the year, the gain must be accompanied by the additional tax.

Where Do You Get Investment Bonds?

Investment bonds are known to many as insurance bonds, single premium bonds, unit-linked bonds, and with-profit bonds. You can get bonds with the help of your financial adviser, or you can get them yourself from an insurance company. If you’re contemplating if insurance bonds are for you, it would be an excellent idea to talk to your Independent Financial Adviser (IFA) for extra clarification.

Bottom Line

Taking the time to put your funds into investment bonds is a long-term investment that pays.  Every investment has its perks, and so does this. This article was designed to enlighten you on the ups and downs of bonds, educating you on whether they are for you or not. Taking the right step towards proper investment requires that you take the time to research adequate information. However, no matter how useful any information is, your personal input is necessary, as your present situation might prompt some needed changes.

This article is intended to be used, and must be used for educational purposes only. It is imperative that you do your personal analysis and make your investments based on the situation you find yourself in at the moment. For more information, you should seek advice from an Independent Financial Adviser in connection with this information and verify any information you wish to make use of from this article, whether for the purpose of making an investment decision or otherwise.