Even without the extreme volatility in the value of all asset classes that we have experienced over the past year most would agree that portfolio performance is substantially driven and influenced by it’s asset allocation and the specific investments representing each asset class.

It is also, increasingly so, that most asset classes and specific investments can be accessed either directly (usually in the shape of UK or offshore collective investments and, for many, via investment platforms) or via any number of retail investment “wrappers” including registered pensions, ISAs, UK and offshore bonds. Especially in a world moving towards (where it is not already at) neutral pricing between wrappers, this means that one of the main consequences of the choice of wrapper to surround the portfolio will be taxation, both of the investment fund or wrapper and of the investor.

Most would consider the registered pension wrapper (whatever precise form it takes) to be the most obvious “tax no brainer”. This will be so for most who are happy with the form of benefits that the registered pension delivers but for those high earners affected by higher rate tax relief removal (and, of course, those who are restricted by the lifetime/annual allowance) this “truism” may well be questioned.

The increased ISA allowance (from 6.10.2009) for the over 50s and from 6.04.10 for all, will certainly help those looking for a tax effective home for funds outside of a pension wrapper. But once the ISA allowance has been used how about insurance based investment bonds – UK and offshore? What place do these have – especially when compared with collectives?

Well, it all depends on the portfolio, the relative importance of capital gains and income (and what type of income) and, of course, on the tax position, throughout the expected term of the investment and when benefits are to be taken. The amount invested will also be a key determinant. Generally speaking, the smaller the sum invested the less (tax) important will the choice of wrapper be.

For portfolios that are solely or predominantly focussed on providing capital gains then, especially since the introduction of the single 18% CGT rate for individuals (and trustees), the collective will usually look tax preferable. This will be especially so where the investor can effectively use their annual exemption.

However, an investment strategy focussed on capital gains may be seen as carrying higher risk. Most (see the Credit Suisse Global Equity Report and the Barclays Equity/Gilt Report) accept the importance of reinvested income in any equity based portfolio.

Especially for higher rate taxpayers, reinvested income will (all other things being equal) be more tax effective in a UK or offshore bond. The investor being protected from all personal taxation risk until encashment or withdrawal. UK dividends received inside a UK (or offshore) life fund will bear no tax at that point and even interest and rent will only be taxed at 20% inside a UK life fund and be tax free in an offshore bond.

Other factors to consider include indexation relief being available for capital gains made or reserved for in a UK life fund and a generally lower rate of tax on capital gains assumed at UK life fund level.

Of course, whether a UK bond or an offshore bond gives the best after tax result for a particular investor will depend on the facts of each case. A key factor will, of course, be the (usually) more favourable fund taxation position for the offshore bond but chargeable gains made by the investor under a UK bond will carry a 20% tax credit – even where little or no tax has been suffered by the fund. So .. it all depends. The investment term can play a big part here as the benefit of tax deferment generally increases with time.

There are also the well known “tax effective” extraction strategies to consider for both bonds and collectives including 5% tax deferred withdrawals (bonds), the annual CGT exemption (collectives) and the tax free assignment regardless of assignor and assignee (bonds).

It is also worth keeping in mind that on the death of an investor a collective (UK or offshore) would be revalued for CGT purposes so that all gains accrued (but not realised) to date would be “wiped out” for tax purposes. A UK or offshore bond would however usually be a simpler investment to hold in trust.

So there are many issues to consider – which is, as they say, “all good” for advisers. Especially for the more substantial investments the choice of investment wrapper can make quite a significant tax difference to the net returns received by the investor. Advice is essential. And well informed advisers will know the danger of dogma in making such choices. Even with an 18% CGT rate available to collectives there will still be many portfolios and investors for whom an investment bond (UK or offshore) may be appropriate.

This note is given strictly for general consideration only. Each case must depend on its own facts and so no action must be taken or refrained from based on this note alone. Accordingly, neither the author nor Technical Connection Ltd nor any of its officers or employees can accept any responsibility for any loss occasioned as a result of any such action or inaction.