Investment bonds as life insurance

Investment bonds are sometimes known as single-premium life insurance policies - find out more on the pros and cons of such an investment.

Key points

  • Investment bonds can serve as a type of life insurance policy paid for with a single lump-sum deposit
  • They can have certain income tax, capital gains tax and inheritance tax advantages for an estate
  • The value of the investment can go down as well as up so the final payout might be less than what was paid in

Investment bonds are lump-sum investments that can be used as a type of life insurance.

In the right circumstances they can be a tax-efficient investment option that you can use as a place to store and grow your money, as well as to provide a payout when you die.

They can be particularly useful if you’ve used up your Individual Savings Account (Isa) allowance, as another way to invest while minimising your tax bill.

They can also be a way of avoiding inheritance tax and capital gains tax when they’re assigned to someone else and redeemed after the death of the holder.

Remember, though, as with all investments the value of your initial investment can go down as well as up, and - depending on the sort of bond you choose - the final payout might be less than what you initially paid in.

There are also a number of fees and charges to consider that might mean they’re not a cost-effective solution for your situation.

How do investment bonds work as life insurance?How to get the right life insurance

Investment bonds are sometimes referred to as single-premium life insurance policies.

This is because, unlike the regular monthly payments you make into a standard life insurance policy, with investment bonds you usually make one lump-sum deposit, typically of at least £5,000-10,000.

This lump sum is then invested, usually in a range of shares and funds, and the returns, if any, can add to your initial investment, or provide an income while you’re still alive.

However, there’s usually a set payout in the event of your death, for instance 101% of the value of your bond. The amount may be higher in the event of accidental death.

Some policies let you pick and choose the funds and shares held in your investment bond; others are fully managed for you.

Withdrawals from investment bonds

Many investment bonds are whole of life, so there’s no minimum term.

Did you know...?

  • Investment bonds are intended to be mid- to long-term investments so there may be surrender penalties for cashing them in during the early years

However, they’re supposed to be mid-to-long-term investments, so there may be surrender penalties in the early years if you want to cash them in.

There may also be tax to pay if you redeem your investment bond, although you can make withdrawals of up to 5% each year without triggering an immediate tax liability.

Remember, if your withdrawals exceed the investment’s growth, you’ll erode your original investment.

Check the conditions of your individual policy to find out what charges may apply for partial or full withdrawals.

Tax on investment bonds

Investment bonds are often sold as having a number of tax benefits, with potential savings on income tax, capital gains tax and inheritance tax.

Like Stocks and Shares Isas and self-invested personal pensions (SIPPs), they are a type of tax-efficient ‘wrapper’ for your investment.A piggy bank wearing a pair of sunglasses

However, their tax implications are actually rather complex, so you might want to seek advice from an independent financial adviser before deciding if they’re the right option for you and your estate.

All gains and income in an investment bond are taxed at the basic rate at source, but you can withdraw up to 5% a year for up to 20 years without paying any additional tax due if you’re a higher or additional rate taxpayer.

If you don’t use your tax-free allowance for the year, you can carry it over - so in three years’ time, if you haven’t made any withdrawals, you could withdraw 15% without paying any immediate tax on it, which minimises your income tax bill if you’re a higher or additional rate taxpayer.

However, as the tax is deferred, when the bond matures or is cashed in, the tax becomes due.

This is sometimes partially or wholly avoidable by a method known as top-slicing - this is where the profit is divided over the total life of the bond, which may reduce the tax bill for some - or by assignment of the bond to someone else.

Assignment of investment bonds

The holder of an investment bond may assign their bond to someone else while they’re still alive, which can reduce or remove the tax liability.

For instance, a higher-rate tax payer might assign their investment bond to a spouse or child who is a basic-rate taxpayer.

So, if a higher rate taxpayer pays £10,000 for an investment bond in 2010 and in 2015 it’s worth £15,000 after basic-rate tax has already been taken, they might choose to assign it to their child who is a basic rate taxpayer.

Assuming the child was not pushed into a higher tax bracket by the £5,000 gain (divided by five due to the effect of top slicing, so £1,000 per tax year), they would benefit from the whole £5,000 profit by cashing in the bond.Savings and Isas: Piggy bank and coins

If the higher-rate taxpayer had cashed the bond, they would have had to pay the extra tax on the £5,000 gain.

Fees and charges

There’s usually a charge to pay when you take out an investment bond, which is either a percentage of the lump sum invested or a fixed amount.

This charge can be quite high, which is one reason why investment bonds are typically seen as mid-to-long-term investments.

Some investment bonds sold as life insurance offer a guarantee that your investment won’t lose any money, but the charges for these products are usually higher.

If you choose an investment bond where you can choose which funds and shares your bond invests in, you may have to pay charges for buying and selling these.

Finally, as these are not intended to be short-term investments, there’s usually a charge for cashing them in during the first few years.

By Derri Dunn