Question
I recently read an article where it was mentioned that you were concerned that investment bods are still being sold on the high street. Coincidentally I have recently met with my IFA who recommended I took out a Prudential Flexible Investment Plan, which I would have to keep for 5 years to avoid early withdrawal/closure penalties. I am looking to invest an amount up to £40,000 which does not have to generate income for me. I will be a basic rate tax payer when a pension starts at the end of October.
When I challenged him about this type of investment he was quite defensive and advised that they are still better than unit trusts.
I find it really difficult to understand the differences between types of investments (I do understand ISAs, equities purchased from single companies, ordinary savings accounts, etc) where the amount can be split between different asset classes.
I would be really grateful if you could advise me. Am I being taken for a ride?Answer
Being cynical the Prudential Flexible Investment Plan probably is better than a unit trust for your adviser (because it'll pay him more commission), but it's unlikely to be so for you.
The Prudential plan is an investment bond and, as these things go, it's one of the better ones because there's a good range of funds that can be held within.
However, it's important to appreciate that investment bonds are basically just a wrapper, subject to special tax rules, within which you can hold fund investments similar to unit trusts. So tax is what's key here.
Within an investment bond all investment income and gains are automatically taxed at basic rate and this can never be reclaimed. Provided you remain a basic rate taxpayer you'll unlikely ever have any further tax to pay, so it's neutral, i.e. no tax benefit for basic rate taxpayers.
If you're over 65 there is a potential benefit in that any annual withdrawals you make up to 5% of the sum invested don't count towards you increased age-related income tax allowance, although when you eventually sell the bond these withdrawals plus gains are treated as income when calculating your age-allowance that year.
Compare this to a unit trust or shares where gains are liable to capital gains tax and income, unsurprisingly, to income tax.
For a basic rate taxpayer the after tax income is effectively the same as an investment bond, i.e. it's been taxed at 20%. For those over 65 the investment bond might hold an advantage when withdrawing income re: the age allowance.
But gains can be offset against your annual capital gains tax allowance, currently £10,100. So on a £40,000 growth investment it's likely you can enjoy tax-free growth versus an investment bond where it would be taxed at 20%.
This could make a significant difference - assume £40,000 invested for 10 years with 6% annual gains before tax, a capital gains taxable investment would grow to £71,634 (assuming you use your allowance) whereas the bond would only grow to £63,925.
Better still, if unit trusts or shares are held within an individual savings account (ISA) then gains and interest (from corporate bonds and cash) will automatically be tax-free, while dividends will have no further tax deducted (basically no difference for a basic rate taxpayer). Also, ISA income does not need to be entered on a tax return so it won't affect your age allowance.
You can invest up to £10,200 into an ISA each tax year (rising by inflation from next year), of which up to half can be in a cash ISA.
If your ISA allowance is available and the adviser has ignored this when recommending the investment bond I am deeply concerned as it's blatantly poor advice.
If your ISA allowance isn't available then maybe the adviser believes the investment bond will be more tax efficient because it won't affect your age allowance, but the unit trust/shares route will still likely be the more tax efficient overall - hence I believe his advice is probably being driven by what's best for him, not you.
Unit trusts usually pay 3% initial and 0.5% annual commission. Check the commission the adviser will receive for selling the investment bond, it'll almost certainly be higher.
Maybe a good time to find a new adviser...
You can read more about the age allowance on our income tax page and my answer to this question, but here's a quick summary:
If you're aged over 65 you enjoy a higher personal income tax allowance, currently £9,490 if 65-74 and £9,640 if older (the standard allowance is £6,475).
For every £2 your income exceeds £22,900 you lose £1 of allowance, although you can't fall below the standard £6,475. This means that for some aged 65-74 their income between £22,900 and £28,930 is effectively taxed at 30%, i.e. 20% basic rate tax plus the lost personal allowance which is equal to 10%.
So, depending on your income, the investment bond could save you 10% tax on income versus a unit trust/shares (ignoring ISAs). But then a unit trust/shares will save you 20% tax on gains - likely to be more valuable over time unless you require a high income and don't use ISAs.
I recently read an article where it was mentioned that you were concerned that investment bods are still being sold on the high street. Coincidentally I have recently met with my IFA who recommended I took out a Prudential Flexible Investment Plan, which I would have to keep for 5 years to avoid early withdrawal/closure penalties. I am looking to invest an amount up to £40,000 which does not have to generate income for me. I will be a basic rate tax payer when a pension starts at the end of October.
When I challenged him about this type of investment he was quite defensive and advised that they are still better than unit trusts.
I find it really difficult to understand the differences between types of investments (I do understand ISAs, equities purchased from single companies, ordinary savings accounts, etc) where the amount can be split between different asset classes.
I would be really grateful if you could advise me. Am I being taken for a ride?Answer
Being cynical the Prudential Flexible Investment Plan probably is better than a unit trust for your adviser (because it'll pay him more commission), but it's unlikely to be so for you.
The Prudential plan is an investment bond and, as these things go, it's one of the better ones because there's a good range of funds that can be held within.
However, it's important to appreciate that investment bonds are basically just a wrapper, subject to special tax rules, within which you can hold fund investments similar to unit trusts. So tax is what's key here.
Within an investment bond all investment income and gains are automatically taxed at basic rate and this can never be reclaimed. Provided you remain a basic rate taxpayer you'll unlikely ever have any further tax to pay, so it's neutral, i.e. no tax benefit for basic rate taxpayers.
If you're over 65 there is a potential benefit in that any annual withdrawals you make up to 5% of the sum invested don't count towards you increased age-related income tax allowance, although when you eventually sell the bond these withdrawals plus gains are treated as income when calculating your age-allowance that year.
Compare this to a unit trust or shares where gains are liable to capital gains tax and income, unsurprisingly, to income tax.
For a basic rate taxpayer the after tax income is effectively the same as an investment bond, i.e. it's been taxed at 20%. For those over 65 the investment bond might hold an advantage when withdrawing income re: the age allowance.
But gains can be offset against your annual capital gains tax allowance, currently £10,100. So on a £40,000 growth investment it's likely you can enjoy tax-free growth versus an investment bond where it would be taxed at 20%.
This could make a significant difference - assume £40,000 invested for 10 years with 6% annual gains before tax, a capital gains taxable investment would grow to £71,634 (assuming you use your allowance) whereas the bond would only grow to £63,925.
Better still, if unit trusts or shares are held within an individual savings account (ISA) then gains and interest (from corporate bonds and cash) will automatically be tax-free, while dividends will have no further tax deducted (basically no difference for a basic rate taxpayer). Also, ISA income does not need to be entered on a tax return so it won't affect your age allowance.
You can invest up to £10,200 into an ISA each tax year (rising by inflation from next year), of which up to half can be in a cash ISA.
If your ISA allowance is available and the adviser has ignored this when recommending the investment bond I am deeply concerned as it's blatantly poor advice.
If your ISA allowance isn't available then maybe the adviser believes the investment bond will be more tax efficient because it won't affect your age allowance, but the unit trust/shares route will still likely be the more tax efficient overall - hence I believe his advice is probably being driven by what's best for him, not you.
Unit trusts usually pay 3% initial and 0.5% annual commission. Check the commission the adviser will receive for selling the investment bond, it'll almost certainly be higher.
Maybe a good time to find a new adviser...
You can read more about the age allowance on our income tax page and my answer to this question, but here's a quick summary:
If you're aged over 65 you enjoy a higher personal income tax allowance, currently £9,490 if 65-74 and £9,640 if older (the standard allowance is £6,475).
For every £2 your income exceeds £22,900 you lose £1 of allowance, although you can't fall below the standard £6,475. This means that for some aged 65-74 their income between £22,900 and £28,930 is effectively taxed at 30%, i.e. 20% basic rate tax plus the lost personal allowance which is equal to 10%.
So, depending on your income, the investment bond could save you 10% tax on income versus a unit trust/shares (ignoring ISAs). But then a unit trust/shares will save you 20% tax on gains - likely to be more valuable over time unless you require a high income and don't use ISAs.
Read this Q and A at http://www.candidmoney.com/questions/question286.aspx
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