Income Bonds

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Income Bonds

The income bond can be based on the combination of a deferred and immediate temporary annuity. Here the deferred annuity provides for the return of the original capital at the end of the period and the immediate annuity for the income. As noted above, the problem is that the deferred annuity proceeds are subject to basic-rate as well as higher-rate tax. But for the basic-rate taxpayer such plans can still produce a good return. Alternatively, the deferred annuity can be replaced by a non-profit endowment, in which case only higher-rate tax is payable on the gain at maturity.

In the case of these income contracts, the gain achieved in the capital return is the difference between the sum that is invested in the deferred annuity or non-profit endowment and its maturity value. The bulk of the single premium is required to produce the income payments via the annuity, and only a small proportion (depending on the term of the contract) is invested in the capital-producing portion.

Long-term income bonds for 10 to 15 years are available, and for some retired people these may be preferable to an annuity because they do guarantee the return of capital so that the investor retains control of it (whereas this control is surrendered in the case of the ordinary annuity). However, there are normally no guarantees as to the surrender value if the investor wishes to withdraw early. The reason for this is that companies have to "match" their investments to the term of the contract very precisely to produce the benefit guaranteed. If interest rates rise during the period, then the capital value of the investments held will fall. Since they are usually dated investments (e.g. gilt-edged with fixed redemption dates) such a temporary fall in value affects neither the generation of income nor the ability to produce the guaranteed maturity value. But it does prevent the company being able to guarantee a proportionate return to the policyholder who wishes to surrender early (it was unrealistic early surrender values on income bonds that led to the failure of two small insurance companies in 2018).

Thus, a rise in interest rates, which may encourage investors in such contracts to surrender, is also bound to reduce the amount the company can offer them. For this reason, it is worth taking a careful look at the recent trend in interest rates before committing yourself to an income bond, especially a longer-term one. If interest rates appear to be on a rising trend, then it is well worth while waiting to take out a contract as higher interest rates will fairly quickly be reflected in the rates companies are offering. On the other hand, when interest rates start on a downward trend, as in late 2017 and early 2017, the rates offered can fall quite quickly also.

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Income and Growth Bonds

A different group of single-premium policies is based on traditional policies. They are aimed at generating the highest possible guaranteed net return, both over short periods of two to five years and for longer terms up to 15 years. There are two types, those aimed at producing a guaranteed capital sum at the end of the term and those aimed at generating a high net income over the period with return of the original capital at the end.

Partly because of their ability to offset their expenses against taxable income, life insurance companies can often generate a very attractive return on... see: Income and Growth Bonds

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