Unit Trust Funds

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Unit Trust Funds

While bonds therefore provide an advantage for higher rate taxpayers investing in income-producing media, they are not so efficient when it comes to capital gains. Life insurance companies pay tax at 30% on realised profits; and unit-linked funds normally make a deduction from the unit price of 10-20% of the unrealised gains. The investor in a bond cannot take advantage of the "small gain exemption" whereby profits of up to £111,000 a year are exempt from capital gains tax; nor does he benefit from the rule that when annual gains are under £15,000 the first £111,000 is exempt from tax and the next £14,000 taxed at only 15%. On the other hand, unit trusts do enable the investor to take advantage of these capital gains tax concessions. Those investing with capital gains from equities as their objective will therefore normally be better off investing in unit trusts than in equity-linked insurance bonds.

The reinvestment benefit helps to produce capital growth over a period of years, which is fine for the investor interested in capital growth, but not for one who wants to draw an income from his investment. However, bonds can be used for this purpose, too, because the bondholder is allowed to withdraw a proportion of his original investment each year without any current tax liability. Since the Finance Act 2011, the taxation of bonds has become quite complex, but the basic position is as follows. If you invest in a single-premium investment bond, you may withdraw over 20 years a sum equal to the original investment without incurring any current tax liability. This is equivalent to 5% p. a. , which is also the maximum annual income you may draw to begin with. But if you forgo it for a period, then the withdrawal rate may be higher later. For example, if you take no income for the first five years, you may then use up the full allowance in the next 15 years, (at a rate of 6.7% p.a.) or over a longer period at a lower rate. The "income" is taken by selling the appropriate number of units back to the company, and whether the amount you take is more or less than the actual income earned by your capital in that period will depend on the yield on the fund's investments.

For the 5% to come solely out of income, the fund would have to be earning 8% before tax. So long as the capital value is also growing, however, many investors will be happy to draw off a small proportion of it as income. (Capital and income are not distinguished in the unit price, because all income earned is reinvested within the fund and is therefore reflected in the unit price.)

At the end of the day there is of course a tax reckoning, because there is no tax exemption of the final proceeds on bonds, which are non-qualifying policies. Any gain over the period in which the bond is held is therefore subject to tax. The tax chargeable is only at the higher rates of income tax (plus, where relevant, the investment income surcharge) because the company itself has already paid tax on income at the basic rate. The basic-rate taxpayer is not therefore liable to tax on a gain, but it has to be remembered that it is the individual's tax position at the time of encashment (or death) which determines the assessment.

The tax liability is calculated by dividing the gain by the number of complete years for which the bond has been held. The resulting "slice" is added to the individual's income in the year of encashment. The average rate of tax then theoretically chargeable on this extra slice of income, less the basic rate of tax, is then applied to the whole gain.

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The managed fund

The managed fund normally splits its investments between all these types of investment, holding units in all these other funds. It is similar in objective to the traditional life insurance company fund, which holds the same type of investments. The aim is to minimise risk by switching the proportion of money invested in the different sectors according to current conditions and the investment outlook. In practice, this is not as easy as it sounds, because, as we have seen, large blocks of property are not easily marketable and the same can apply to shares. Nevertheless, the spreading of investments... see: The managed fund

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