The secret of success in an insurance bond

The adjective 'insured' puts many potential savers off. The product technically is a 'single premium whole of life' insurance policy but its prime purpose is for investment. Life cover is minimal – usually around 101 per cent of the value at death.

Yet, there lies the secret to its success. As a life policy, the bond enjoys a different tax status than saving directly in shares or unit trusts. Any growth may be subject to income tax, not capital gains tax.

Up to five per cent of the initial investment can be withdrawn annually for up to 20 years with no tax to pay – a clear benefit to high rate tax payers who want an investment income.

As bonds are considered non-income producing, unless more than five per cent is taken, there is no need to declare the bond on your tax return.

Because of both the establishment fee and time to allow the bond to grow effectively, treat such savings as medium to long term.

However, usually money can be accessed quickly.

For those with retirement in mind, insurance bonds offer two distinct advantages:

n can be written in trust to ensure funds are passed to beneficiaries on death of investor;

n exclusion from any means-tested assessment for residential home costs.

Many savers like the diversity of funds offered by a bond.

It is a money umbrella and, if unhappy about the direction one fund is taking, a switch to another fund within the bond does not create a charge for tax purposes.

Bonds may be on or off shore.

The latter is useful for anyone likely to move abroad who will benefit from rolling-up income on a gross basis.

An offshore bond can be set up with no lives assured which means it does not end on death but has a fixed life usually of 99 years.

This is known as a capital redemption basis. Ownership can be passed and the bond encashed at the most convenient time, which makes this a good inheritance planning option, ensuring it is written in trust.

Insurance bonds do not carry the same protection as some investments. If the deposit is made through a life insurance company, the compensation schemes consider the company to be the depositor rather than the individual and therefore exclude it from protection.

Consider the financial strength of the company using the rating agencies. An independent financial adviser will help with such information. The FSA regulates that life companies are run by fit and proper managers and hold assets to meet liabilities – the topical subject of minimum solvency margins.

However, the underlying investments are also regulated and assets are ring-fenced.

Leading stockbrokers act with IFAs to provide investment advice for insurance bonds.

Jonathan Baker at Leeds based Charles Stanley says discounted gift trusts using an offshore bond is one of their most popular routes, working notably with Royal Skandia in the Isle of Man and Clerical Medical.

HSBC through its Premier IFA division checks the financial strength of a provider, investment performance and terms and conditions before making any recommendations. Among those it tips are Prudential Flexible, Aviva Portfolio, Legal & General Portfolio and Sterling Assurance.

There are several forms of insurance bond. With-profits ones usually hold a combination of shares, fixed interest including government stocks, and property.

Where the provider is a mutual, such a friendly society, members receive their dividends as bonuses with some money withheld to average out for years of poor performance and to pay on termination of the policy.

In its quarterly analysis, Moneyfacts says the top performance for with-profits bonds over five years of a single 25,000 premium was achieved by Aegon Scottish Equitable (Growth) with 34,042, followed by the same provider but its Cautious bond with 33,074.

Wesleyan Assurance was in third place with 32,734. The lowest was 23,280 (Harrogate based Engage Mutual).

Over 10 years, the star was Healthy Investment with 38,830, followed by Prudential Flexible with 37,012 and NFU Mutual Flexibond on 33,032. The worst performer paid 30,801.

Annual bonuses are currently 2.25-3.75 per cent. Watch for the date when a bond can be cashed without a 'market value adjustment' (MVA) being imposed. On average, this is a 2,624 penalty on five-year bonds. Helpful advice is available at the website exitwith-profits.co.uk

Unit-linked bonds form the second group where the investment is linked into either unit trusts or open-ended investment companies (OEICs). In popularity, they have taken over from with-profits bonds. Both with-profits and unit-linked are available on and offshore.

Distribution bonds is a third, usually onshore, option where the underlying fund pays income.

Multi-manager is a further type. The advantage is to spread the savings risk. It may be a 'fund of funds' or a 'manager of managers' (where leading stockpickers select for a specific mandate).

Defaqto, an independent financial researcher, has made a study of the insurance bond market.

It reveals a considerable variation in the number of funds per bond.

Some are unlimited (such as Canada Life Flexible and Select, Clerical Medical, HSBC Select, Scandia SIS and Winterthur Life) but some limited to one (Engage Mutual) or three (MetLife, Teachers, Wesleyan), all onshore. Most offshore bonds are unlimited on fund numbers.

The number of free annual switches between funds within a bond also shows disparity. According to Defaqto, this may be zero (offshore many with Canada Life, Friends Provident, Hansard Europe, Royal London, Royal Skandia) but again can be unlimited.

If ethical investing within an insurance bond appeals, there is a good choice.

Bonds are also available with guarantees, either a fixed income for a specific period (20 years onshore and life offshore) or a capital sum paid on a specific day or death.

It is usually possible to secure any capital growth achieved at stated time periods so that it cannot be taken away if markets move adversely.

If such guarantees appeal, look at MetLife (both on and offshore bonds) and Aegon Ireland (offshore offering guaranteed income for life).