In recent times, tax changes have given rise to increased consideration of insurance bonds with regard to open-ended investment companies, for particular clients. It is an interesting comparison because bonds and Oeics are at opposite ends of the investment spectrum.
An Oeic generates income for the investor, although with accumulation shares, income is not distributed but instead reinvested and added to capital. Even so, the distribution remains income for tax purposes. In other words, amounts reinvested are taxed as income accruing to investors in the same way as if they had been distributed. The fact that distributions do not hit the bank account is not relevant.
In contrast, bonds are non income-producing investments. There is no such thing as income from a bond.
In broad terms, Oeics have traditionally been attractive to investors who can use their annual capital gains tax exemption, for example via successful bed & breakfasting; use their savings allowances via interest Oeics; and use their dividend allowance via equity Oeics.
An Oeic fund is not guaranteed to pay interest but instead it will only pay interest rather than dividends if the fund is more than 60 per cent invested in interest-bearing type investments. The dividend allowance was halved from £2,000 to £1,000 and then halved again to just £500 for 2024-25 and 2025-26. Savings allowances have not been reduced but they have been frozen.
There is therefore a growing likelihood of paying tax on income exceeding allowances that might not currently even be needed by the client. If so, the fact that an Oeic fund must distribute all its net income can be a disadvantage.
Some investors had been willing to pay a bit of tax on their income exceeding these allowances just to access the formerly generous CGT exemption. Also, let’s not forget the low CGT rates of just 10 per cent or 20 per cent above the exemption that we had. These lower and higher rates have been increased to 18 per cent and 24 per cent from October 30 2024.
One of the benefits that investments falling under the CGT regime had in the past compared with investment bonds was the lower rate of tax payable on capital gains. UK bonds pay up to 20 per cent corporation tax on capital gains arising within the fund, whereas a basic rate taxpayer holding an Oeic would only pay 10 per cent where the gain exceeded their annual exempt amount.