Investment bonds are single premium life insurance policies where you invest a lump sum in a variety of available funds. Some investment bonds run for a fixed term and others have no set investment term. When you cash investment bonds in, how much you get back depends on how well or how badly the underlying investments have performed. Both onshore and offshore bonds are available, but onshore bonds have become increasingly rare due to their relative tax inefficiency compared to offshore bonds and ISAs.
Some investment bonds might guarantee your capital or your returns. These guarantees usually involve a counterparty. If so they carry the risk of counterparty failure.
For an onshore bond, all gains and income earned within an investment bond are taxed annually at 20% and paid directly out of the investment bond compared to an offshore bond, which benefits from gross roll up where no tax is deducted at source. This can help to minimise your income tax bill, especially if you are a higher rate or additional rate taxpayer.
However, your tax bill does not disappear entirely. Instead, the tax is deferred and any additional tax due will be payable at the time you cash in the bond, or when it matures.
All capital gains are treated as income at this point. For an onshore bond, you might have an additional income tax bill if your gains push your income over the higher or additional rate tax threshold in the year they mature as you will have already been deemed to have paid basic rate tax. For an offshore bond, as no basic rate tax has been paid, gains within the basic rate band are taxed at 20% and then 40% and 45% for higher or additional rate taxpayers.
Withdrawals of up to 5% a year are allowed for up to 20 years without incurring an immediate tax charge for both onshore and offshore bonds. If you do not use your 5% allowance in a given year, the allowance is carried over to the following year i.e. if you make no withdrawals in year one, you could draw up to 10% the following year without incurring a tax liability.