investment bond taxation

Investment Bonds – What are they and how to do they work?

A type of life insurance policy, an investment bond is a lump sum investment into several available funds. There are several types of investment bonds and the money you gain from an investment is dependent on the success of your investment.

This may all sound very confusing, but this simple guide to investment bonds and their intricacies will hopefully provide you with vital information to help you in any future decisions.

In this article, we will cover:

·         What are investment bonds? – we will define investment bonds

·         How do investment bonds work? – we will provide an outline into how they work, the different types available and any advantages and disadvantages

·         What is the tax on investment bonds? – using information from HMRC, we will show how they are taxed

·         What are the best investment bond policies? – we will provide you with information about some of the best bond investments available

·         How do investment bonds work in relation to avoiding inheritance tax? – we will explain how you may be able to use investment bonds to avoid a large inheritance tax bill

What are investment bonds?

In the UK, investment bonds can provide the opportunity for long-term growth on your invested cash. Classed as a single premium life insurance policy, investment bonds are a form of investment product that can help provide a regular income throughout your pension.

Although a portion is paid out upon your death, you are able to access your invested cash which has experienced an increase in its value due to a successful investment.

Usually, you purchase an investment bond from your life insurance provider, or through a financial adviser. These well invest your single premium on your behalf, which can experience capital bond growth up until you withdraw money from the policy.

This video provides a useful insight into bonds and how they work.

How do investment bonds work?

Usually, you will invest a lump sum. Typically, this varies between £5000 and £10000 as a minimum.

The majority of investment bond policies work on a whole of life basis, with no minimum term option included. This is not to say that some investment bond policy providers will not provide a minimum term option, but it is worth noting these will often incur surrender penalties, so it is worth checking.

This BBC article provides more information about bonds and how they work.

After taking out a bond investment, you and your provider/ financial advisor will have a choice of funds you may wish to invest your money into. There are two types of funds available, these include:


in this form of life insurance investment, a lump sum payment is usually required. A with-profits investment bond purchases a ‘sum assured’, typically in the form of units from the insurance provider’s profit fund which are then invested in several assets such as shares and property.

The value of your investment can increase with the addition of several bonuses added each year. These are known as reversionary bonuses, and once added they cannot be removed from your investment bond.

This is an attractive quality of a with-profits investment bond, and the investor is therefore protected from the potential fluctuations an investment may face. It is therefore very possible to be able to receive a regular income from with-profits bonds if planned carefully.



in this form of life insurance investment, insurance companies give investors both insurance cover and investment opportunities, which are covered by one single policy.

Acting as a combination of insurance and investment, you will pay a premium which is used to provide you with both with insurance cover, while some of the premium will be invested into things such as equity or the stock market.

When taking out a unit-linked policy, you have control over how much to invest, depending on your circumstance and how much you are willing to invest.

For more information on these types of investment bond plans, don’t hesitate to contact us here at UK Care Guide, and we’ll happily assist with any queries you may have.

taxation of investment bonds

As with many things in life, there are advantages and disadvantages associated with investment bonds. The table below will highlight a few of these for your benefit:

Advantages of investment bonds

  • You can withdraw 5% of your initial investment every year for 20 years, without picking up a tax charge.
  • You are not liable to any basic tax rate on any income, and any financial growth from your investments is not liable to capital gains tax.
  • Can be used to prevent the loss of personal allowance, where income exceeds £100,000. Withdrawals from investment bonds do not count towards the personal allowance threshold.
  • You can arrange for a surviving spouse to receive income from the success of your investments, as well as being able to gift any cash tax-free bonds  from investments to your loved ones or beneficiaries
  • You can withdraw money from your investment bonds at any one time, which is particularly useful when managing your pension
  • There is often a wide range of investment options available to cater for different financial situations and goals

Disadvantages of investment bonds

  • Any form of income or gains that are derived are liable to taxation at rates up to 30%
  • Although money can be withdrawn at any time, if this money is withdrawn within 10 years the policy beginning, some of the profit on your withdrawal is liable to taxation.
  • Depending on your investment bond, there may be minimum balances that have to be maintained throughout the policies duration.
  • You may be charged fees depending on your provider and whether you wish to surrender early
  • You do not have direct control over the day-to-day investment decisions, therefore once the investments are made it may essentially be out of your control.

This Daily Mail article also provides more useful information on investment bonds and how they work.

The taxation of investment bonds

Currently, the taxation of investment bonds occurs at a rate of 20%, which is paid straight out of the investment bond. However, you are able to withdraw up to 5% of the investment every year for 20 years, without facing any additional tax charge.

If you opt against withdrawing this 5% allowance, then that year’s allowance carries over into the following year. For instance, if in one year you did not want to withdraw any of your 5% allowance, the following year you would be able to withdraw up to 10% of your allowance without facing any additional tax charges.

If you are a high earner, currently on a higher tax rate of around 40-45% income tax in that current year, then an investment bond may be a wise option if you want to reduce your income tax bill.

It is worth noting however that your investment bond taxation bill isn’t removed entirely, and any tax owed is deferred and will be payable when you choose to cash in your investment bond. This is because any gains made to capital bonds in an investment are treated as if they are income, so an additional income tax charge could be incurred if you exceed the threshold within that tax year.

This could be avoided through ‘top-slicing’, a method with works by splitting your profits over the duration of your investment bond into the number of years you have held that bond. This can help keep you below the higher tax rate threshold, saving you from paying extra income tax.

capital bonds

What are the best investment bond policies?

There are several websites which allow you to compare investment bonds and the best policies for your situation. If you are unsure whether investment bonds is the correct option for you, then it is definitely recommended that you contact an Independent Financial Advisor.

As always, we are also here to help with any enquiries you may have so don’t hesitate to contact us.

Listed below are some of the most popular rated fixed-rate investment bond policies in the UK:


·         3 year term

·         Fixed rate bond

·         Open with £1000 minimum


·         2 year term

·         Fixed rate bond

·         Open with £1000 minimum

Skipton 5 year -ebond

·         5 year term

·         Fixed rate bond

·         Open with £500

Obviously, these are just a few of the many investment bonds available to you, and there are many more that can cater to varying needs and situations.

How do investment bonds work in relation to avoiding inheritance tax?

Inheritance tax can reduce the amount of money your loved ones may receive following your passing. However, it is possible to legally avoid incurring a huge inheritance tax bill through investment bonds.

By assigning the investment bond as a gift, tax-free bonds can be useful for planning inheritance tax purposes. You may wish to gift your investments to a spouse or other beneficiaries, in which event the gift would be exempt from being liable to inheritance tax.

According to HMRC, the inheritance tax is 40%, and is only charged on the amount of your estate above the threshold. Through investment bonds and Business Relief, your beneficiaries may be exempt from a hefty inheritance tax bill.

Business relief is an investment incentive which allows business relief shares and investments to be passed on free of inheritance tax. Beneficiaries can, therefore, receive the income from an investment bond free of tax, as long as the bond has been owned for at least 2 years.

The Financial Conduct Authority

The Financial Conduct Authority (FCA) regulates and authorise firms and individuals selling financial services in the UK. As a word of warning, the FCA has provided information that suggests ‘UK Investment Bond’ has been operating in the UK without FCA authorisation.

This is a particular example of the dangers with investment bonds and why you should be wary when planning to invest your finances.