By: BILL BLEVINS
Financial Correspondent, Blevins Franks
ARE YOU sometimes confused about the word “bond”? It comes up frequently in investment articles, discussions and even tax planning. There are various uses for the word “bond” in the modern day world of investing. Below are the different meanings explained and how each type of bond can benefit you financially.
Originally the term “bond” in the investment world meant a certificate of debt repayment. A dictionary definition of the word “bond” is “a finance certificate issued by a government or company promising to pay back borrowed money at a fixed rate of interest on a specified date”. It is a solemn promise to do something.
But the word “bond” has somewhat evolved over the years to also represent a generic term for an investment arrangement, although the original meaning is still very much in place.
Fixed interest securities/bonds
These bonds are the ‘original’ investment bonds. When you buy a bond you make a loan to a government, corporation or municipality enabling them to raise capital. The bond is usually held by the investor for a fixed term, during which time a specific rate of interest is paid providing a regular income.
When the term of the bond is completed it reaches ‘maturity’ and the loan with interest is repaid.
Two of the most commonly known types of these bonds are government bonds (referred to as “gilts” in the UK and “treasuries” in the US) and corporate bonds.
Governments need to raise money for their public expenditure and this is usually done through taxation or by borrowing through the issuing of bonds.
Since governments, especially those of developed nations, are considered to be trustworthy and stable the rate of interest is low (usually a fraction more than bank interest) because there is little risk involved.
Corporate bonds are issued in a similar way by corporations. Companies that are established and reliable also pay a fairly low interest rate because the risk to the investor is minimal.
Fledgling companies, or established ones that have taken a downturn, or those based in emerging markets, carry a higher degree of risk and for the use of your cash promise to pay a higher rate of interest.
These latter types of bonds are called “high income” or “high yield” bonds.
Capital guaranteed bonds
Capital guaranteed bonds are not the fixed interest securities type of bond. In fact, they are not a bond as such but a capital guaranteed investment.
There are many ‘guaranteed’ investments on the market and you need to make sure that the vehicle you are interested in really does guarantee a full return of your capital, regardless of market conditions, plus interest which often depends on market performance.
Typically, a 100 per cent capital guaranteed bond promises to repay the investor the full amount of his capital back plus interest, provided the bond has been held for its full term, usually between five and six years, and no withdrawals have been made.
The money is invested in stock markets, which allows you to benefit from the higher rate of return from equities without risking your capital. Even if the markets fall over the period of investment you are certain of receiving back your original capital.
To get the best out of a capital guaranteed investment bond look for a structure that invests in a diversified range of the leading market indices (around four) from across the world.
Gains made in one market should not be affected by any downturns in the third. Some of these investments offer a substantial bonus on maturity if all indices invested in end the investment period above or at the same level as they were on the commencement date.
Investment/life insurance bonds
You may have heard of this type of “bond” by other names as they are also known as Private Client Portfolios (PCPs) or Private Portfolio Bonds (PPBs).
This type of structure provides an advantageous tax efficient vehicle in which you can place your investment assets like equity funds, property funds and also fixed interest bond funds and capital guaranteed bonds.
The method is simple. Instead of holding your investments in your own name, you hold them wrapped up in an insurance bond, where they are protected from taxation.
The assets are ring-fenced from the insurance company’s (assuming you use one in a well regulated jurisdiction like Luxembourg). Another advantage is that you can change the investment mix at any time tax-free.
Costs of the underlying investments are far less as you benefit from the reduced rates which the insurance companies can negotiate.
The investments within this insurance wrapper are usually taxed far more beneficially if no withdrawals are made. Depending on the rules in your country of residence, there is often no income or capital gains tax payable on any of the gains or income made within the bond.
In some countries, when a withdrawal is made it is taxed only on the “element of growth” basis where only a fraction of the amount withdrawn is treated as taxable income, the rest is effectively viewed as a return of capital.
A life insurance bond can be placed in an offshore trust and receive further tax advantages.
If a PPB is held in an offshore discretionary trust, your assets within the “bond” can be placed outside succession law and permanently protected from UK inheritance tax, even if in unforeseen circumstances you later return to the UK to live.