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Life insurance investment bonds

Investment bonds are a type of life insurance paid for with a single lump-sum deposit at the outset, rather than monthly premiums. They’re sometimes known as single-premium life insurance policies.

Investment bonds can be a tax-efficient investment option and can be a good alternative to traditional term life insurance policies, especially if you have several thousand pounds right now you want to grow. But as with all investments, performance can vary and the amount you put it can go down as well as up - although some policies will guarantee you the return of your initial investment following your death.

There’s ultimately more risk and uncertainty involved with an investment bond than a traditional life insurance policy, but they offer flexibility, tax incentives, and potential for high returns that may make them a compelling life insurance alternative for some people.

In This Guide:

How investment bonds work as life insurance

With a standard life insurance policy, you pay monthly premiums for your coverage over the policy’s term. Investment bonds, in contrast, allow you to make a single initial deposit, usually between £5,000 and £10,000, and then make no further payments (unless you want to withdraw some of the funds - more about that later).

This lump sum is then invested across a range of funds and shares. Some policies allow you to pick the funds in which your money is invested while others are fully managed for you.

These investment bonds don’t expire, unlike term life insurance policies. When you die—whenever you die— the value of the bond at that time is paid out to your beneficiaries. Sometimes the payout will be higher following an accidental death. Additionally, with some policies, you can withdraw some or all of the money as income during your life, although a surrender penalty may exist during the first few years of the policy and there may be tax implications.

Risk and return

There are two types of investment bonds, based on the way the money is invested. They come with different levels of risk and potential for return.

  • with-profits: benefits are indirectly affected by investment performance. This is the most common type of investment product sold by insurance providers. The initial sum assured invested is topped up annually by bonuses, based on the performance of the investment.
  • unit-linked: benefits are directly affected by investment performance. The single payment premium buys units in the fund of the investor’s choice. The policy’s value depends on the performance of the fund, or funds, to which it is linked. These policies come with the potential for higher rates of return, but a collapse in the value of the fund could wipe out your investment and any potential payout after your death.

Some policies come with a guarantee of your initial invested capital or returns, meaning you won’t get back less than you put in. These policies often come with higher fees to the provider, however.

Withdrawing money

Unlike with traditional life insurance policies, where you’re paying premiums toward a payout your beneficiaries may never see (if you die after the term is up), with investment bonds you do have some access to your initially invested money. There’s typically a surrender value of your bond, although you might not be able to recoup it within the first few years of the policy. Investment bonds are intended to be a medium- or long-term investments and you’ll face penalties for trying to cash them out early. There also might be tax implications of doing so.

However, investment bonds will generally allow you to make annual withdrawals of their value, up to a certain amount. However, if your yearly withdrawals exceed the fund’s rate of growth, you’ll be depleting the initial value of your investment.

You can withdraw up to 5% of their value each year for up to 20 years without being liable for immediate taxation. Any withdrawal allowance not used one year can be rolled over to the following year. If you don’t withdraw any of the bond’s value for two years you can then cash out 15% of the value in the third year, for instance.

However, that tax liability doesn’t just vanish. It’s just deferred and when the bond is cashed in, those withdrawals over the year will be added to the profit made and taxed as income in that tax year. But that deferral might be particularly attractive to high rate taxpayers, who can delay payment until they fall into a lower tax bracket, say in retirement or in a lean year, or for investors who have already used their annual capital gains tax allowance.

Fees and charges

On top of the initial investment deposit, you may face charges at the outset of the policy and throughout. For years, investment bonds were criticised for their excessive fees, but their charging structure has changed in recent years to make them more attractive investment vehicles and life insurance alternatives.

But you will still face fees to the insurance provider, which may include:

  • charges when you take out the bond
  • higher initial charges if you opt for a bond that guarantees your initial investment
  • early surrender penalties if you want to withdraw money within the first few years

Tax implications of investment bonds

Investment bonds have a number of tax benefits, including savings on income tax, capital gains tax, and inheritance tax.

Investment bonds can be a tax-efficient vehicle for investment, especially if you’ve used up your Individual Savings Account (Isa) allowance. Income withdrawn from the bond is not subject to basic rate tax and gains made within the bond aren’t subject to capital gains tax. Instead, gains in and income from these bonds are subjected to a life fund tax rate of 20%. 

Additionally, if investment bonds are assigned to someone else and redeemed following the policyholder’s death, they can be a way of skirting inheritance and capital gains taxes on an estate.

The tax implications of investment bonds are complicated, and you may wish to speak to an independent financial advisor about them before taking out an investment bond.