What is a personal investment bond and how is it taxed in the UK?

Full answer

A personal investment bond (also called an onshore investment bond or insurance bond) is a single-premium life assurance policy issued by a UK insurance company, used as an investment wrapper. They are popular for medium-to-long-term savings, particularly for higher-rate taxpayers and for IHT trust planning. How they work: you pay a single lump sum (the premium) into the bond. The insurance company invests it across a range of funds (unit-linked or with-profits). The bond has a nominal life assurance element (typically 101% of the fund value on death), making it a qualifying life policy for UK tax purposes. The 5% withdrawal allowance: each policy year, you may withdraw up to 5% of the original premium without triggering an immediate tax charge. This allowance is cumulative -- unused amounts carry forward. If you do not withdraw in year 1, you can withdraw 10% in year 2 (5% + 5%). This is a deferral, not an exemption: the deferred amounts reduce the cost basis and increase the eventual chargeable event gain. Internal tax treatment: unlike investments held directly, the bond's internal fund pays tax on income and gains (corporation tax at insurance company rates). This deemed tax payment is treated as basic-rate income tax already paid -- the 'non-repayable credit.' Basic-rate taxpayers therefore have no further personal tax liability when a chargeable event occurs. Chargeable events: a chargeable event occurs on full surrender, assignment for money, death of the life assured, policy maturity, or when the cumulative 5% withdrawals exceed the allowance. At a chargeable event, a gain is calculated: proceeds minus premiums paid minus previous gains already assessed. This gain is treated as the top slice of income for the tax year. Higher and additional-rate taxpayers: pay tax at 20% extra (higher rate, 40% total minus the 20% credit) or 25% extra (additional rate, 45% total minus 20% credit) on the chargeable gain. Top-slicing relief: this can significantly reduce the tax payable. The gain is divided by the number of complete years the bond was held (the 'top slice'). The slice is added to your other income to determine which tax band applies. If the slice falls within the basic-rate band, no further tax is payable. Top-slicing effectively spreads a large gain over many years for rate-band purposes. Trust use: onshore bonds are commonly placed in discretionary trusts for IHT planning -- the bond is a gift into trust (potentially a CLT above the NRB), and the trust can make 5% withdrawals for beneficiaries. The bond's internal basic-rate tax payment makes it administratively simpler for trusts (which pay 45% tax on income above GBP 1,000). Comparison with ISAs and pensions: bonds offer more flexibility than pensions (no contribution limits, no minimum retirement age) but are less tax-efficient on entry than pensions (no upfront tax relief). ISAs are generally more tax-efficient for basic-rate taxpayers than bonds.

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