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An insurance bond is usually used as a single premium life insurance, but in contrast to single premium life insurance it is used for investment purposes. Its main purpose is to be used for long-term capital growth. It is very popular investment instrument that is offered by life insurance companies. Normally life insurance bond is seen as a good value investment vehicle as it not only gives high chances to get return on the premiums paid but also gives the individual a life insurance policy. The main difference from other insurance instruments used for investment purposes is that in the beginning a lump sum is paid in order to get a life insurance bond.
First of all, this kind of insurance can build value over time. Usually as it is invested, the longer it is kept and not withdrawn, the higher overall return on the bond can be expected. One more advantage is that it is not required to keep all the sum invested until the moment of withdrawal or when agreed term for life insurance policy ends. It is possible to cash out part of the money. It makes life insurance bond even more attractive among its users.
Moreover, life insurance bond is often used for tax benefit purposes. In many countries, as well as in UK, unusual approach is used when dealing with taxes on gains from insurance bonds. Usually gains will be untaxed, so by investing into insurance bond and not into other instruments it is possible to save quite significant amount of money.
Furthermore, having insurance bond is convenient as it is possible to choose in what kind of financial instruments the lump sum paid can be invested. It is possible to select few investment instruments and form a portfolio from them. Moreover, it is often available to change the funds in which the money is invested. Thus, this creates more flexibility when dealing with your own money.
However, it is must be remembered that if the person is not an experienced investor, it is advisable to use the advice from the professionals from the insurance company or other financial institutions. Insurance company is always trying to increase the value of the portfolio as it gets them more clients and higher return from investments made by the insurance company itself.
Moreover, it must be remembered that if the person has some liquid investments, they can be used by the government to cover the person’s long term nursing care expenses. However, if insurance bond is used as an investment, than there is no possibility that such action could be taken.
Insurance bonds also have some disadvantages. First of all, this instrument is not very easy to understand, thus in such cases it is advisable to treat investments with extra care. Moreover, it has some risks even though they are much lower compared to other investment possibilities. It is so because the money is invested into financial markets that have tendency to fluctuate. Thus, insurance bond is a better alternative for long-term purposes because long-term fluctuations of the financial markets are less significant.
Moreover, insurance companies charge for withdrawals. It is usually more convenient to cash out only up to 5 percent of invested amount as higher charges will be made for a client by the insurance companies if a bigger amount of money is cash out. Moreover, usually insurance bonds have a minimum limit that can be invested. Although the sum is not that high it still creates some barriers for those who want to use this kind of insurance instrument.
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There are two types of policies: qualifying and non-qualifying policies. The main difference is that qualifying policies holders do not attract further taxes on income gained whereas non-qualifying policies can result in higher tax bills. Usually non-qualifying are those instruments where monthly or annual premiums must be paid. Thus, single premium life insurance bond is treated as non-qualifying policy because only lump sum payment is paid in the beginning.
The question can arise why the insurance bonds are popular among investors if they are taxable. The answer consists of two parts: one of them is that the insurance company may already have paid taxes on their funds and another part is called top-slicing relief.
Usually insurance companies pay taxes on their gains. Thus, in order to avoid double taxation insurance bondholders may not need to pay taxes. However, situation can arise when income from insurance bonds can put the holder into higher tax bracket and then he will need to pay taxes for the income above the tax bracket. In such case, top slicing relief helps to avoid higher tax bill.
Let’s take an example where if the person gets additional £1,000 of income he will need to pay additional taxes for a part of income higher than those £1,000. The individual has £7,000 of gains from his insurance bond policy in this year. Normally he would need to pay taxes from £7,000 – £1,000 = £6,000 of income. If the person now has moved to 25% tax bracket he will need to pay additional £6,000 * 0,25 = £1,500 taxes.
However, top-slicing relief allows adjust an income to be over the term of insurance bond. If the person took a bond for five years than it is allowed that these £7,000 of income are distributed equally for term of bond, which in this case is 5 years. Thus, the person will need to pay the taxes only from £7,000 * 0,2 – £1,000 = £400 of income. Thus, it could lead into paying additional taxes only equal to £400 * 0,25 * 5years = £500 instead of £1,500 in normal situation.
Moreover, because of tax treatment, life insurance bond is often offered as one of the best alternatives for the expatriates. For example, if person took insurance bond in 2003 and returned on 2010, then as he lived in UK only for one year from those seven, he will need to pay taxes only from one seventh of capital gains of owning insurance bond.