Onshore investment bonds in a changing tax landscape

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For many years onshore investment bonds have sat quietly in the background, useful in specific planning scenarios but often overshadowed by directly owned collective investments, alongside tax‑efficient wrappers such as ISAs and pensions. 

The renewed focus on onshore bonds is driven less by product evolution and more by a fundamentally different tax environment. 

That changing environment is largely driven by developments in the UK tax system, which have forced advisers to reassess not just what clients invest in, but how those investments are held. 

 

The tax landscape has shifted 

The renewed interest in onshore bonds cannot be properly understood without first looking at recent changes to the UK tax system.  

Successive reductions in tax‑free allowances have increased the tax drag on unwrapped investments. The CGT annual exempt amount has fallen from £12,300 to just £3,000 for individuals in less than five years. For trusts this is currently £1,500.  If the settlor has created more than one trust, then this amount is split between each trust, up to a maximum of 5 trusts (£300 per trust).   

At the same time, the dividend allowance has been reduced to £500, while income tax thresholds have remained largely frozen, pulling more investors into higher tax bands through fiscal drag. 

For clients holding collective investments outside an ISA or pension, income and gains that were previously covered by allowances are now increasingly taxable, and often at higher effective rates. 

Tax rates today and why structure now matters more 

To appreciate why onshore bonds are being reconsidered, it is helpful to compare how dividends and gains are currently taxed on unwrapped collective investments, and how this differs from the tax profile of an onshore investment bond. 

Dividends: reduced allowances, increased friction 

Dividends from collective investments held outside an ISA are taxed as dividend income. With the dividend allowance now just £500, even modest portfolios can quickly generate a tax liability. 

Following increases in April 2026, dividend tax rates currently stand at: 

• 10.75% for basic‑rate taxpayers 
• 35.75% for higher‑rate taxpayers 
• 39.35% for additional‑rate taxpayers 

This tax applies regardless of whether the income is taken in cash or reinvested, increasing the ongoing tax drag for accumulation clients and introducing reporting requirements that may not previously had encountered. 

By contrast, an onshore investment bond is not an income producing asset in the hands of the client. Dividends arising on the underlying assets are received within the life fund and are not personally assessable as dividend income.  As a result, the bondholder does not receive taxable dividends, does not use their dividend allowance and has no dividend reporting requirement in respect of dividends arising on the underlying assets of the bond.  

Capital gains tax and the value of tax deferral 

With collective investments, CGT becomes assessable when investments are sold. With the annual exempt amount now significantly reduced even partial disposals can crystallise taxable gains. 

Gains, after losses, falling above the exemption are taxed at: 

• 18% for basic‑rate taxpayers 
• 24% for higher‑ and additional‑rate taxpayers 

This can make portfolio rebalancing, fund switching and capital withdrawals increasingly tax‑inefficient unless disposals are carefully staged over multiple tax years. 

An onshore bond sits outside the CGT regime. Instead, the bond is assessed for income tax purposes only when a chargeable event occurs, such as a full surrender, assignment for consideration, maturity or excess withdrawal. Internal fund switches within the bond do not trigger personal tax charges or reporting requirements, allowing portfolios to be actively managed without crystalising personal gains along the way.

In an environment of reduced CGT allowances, the ability to defer and control when personal tax is assessed has become a more valuable feature than in the past. 

Collective investments: transparent, but increasingly tax‑exposed 

Transparency, flexibility and wide fund choice continue to make collective investments a suitable solution for many clients as part of a diversified portfolio.    

However, when held outside tax wrappers, income is taxed as it arises, gains are taxed on disposal.  With allowances significantly reduced, this transparency can result in higher and less predictable tax outcomes, bringing wrapped solutions such as onshore investment bonds into sharper focus as a core structural solution. 

What makes onshore investment bonds different? 

An onshore investment bond is a life assurance policy that holds underlying investments in a life fund on behalf of the policyholder. The life fund pays tax on income and gains broadly at rates aligned with basic rate taxation.  

The client does not suffer personal tax on dividends or gains as they arise. Instead, personal taxation is deferred until a chargeable event occurs. While this does not eliminate tax, it allows the bond holder to control when tax arises, and therefore at what marginal rate of tax the chargeable event is assessed. 

Onshore bonds within a wider investment portfolio 

In practice, many clients invest new money into an onshore bond as part of a wider, diversified portfolio. This is often driven by the reality that key tax allowances such as the dividend allowance and CGT annual exempt amount have already been fully utilised.  

For clients investing with a medium‑to‑long‑term time horizon, the attraction is not short‑term withdrawals, but the ability to allow growth free from any personal liability to dividend tax, capital gains tax and any associated reporting requirements. 

This can be particularly appealing where your client is still in their higher earning years and expect their marginal rate of tax to fall in the future, for example on retirement. By deferring personal taxation until that point, you can help align tax liabilities more closely with your client’s future income positions, rather than their current one. 

Crystallising gains on existing collective investments and reinvesting the proceeds into an onshore bond may also form part of this broader strategy, where appropriate.  This can help  

• Reset CGT base costs 
• Lock in known tax outcomes; and 
• Move future growth into a controlled tax environment 

Once funds are invested within an onshore bond, whether from new money or crystalised disposals, growth can continue without annual dividend or CGT liabilities for the client, and without the need for ongoing tax reporting in respect of the bond. 

The 5% tax‑deferred withdrawal allowance 

Onshore bonds also offer flexibility through the 5% cumulative tax‑deferred withdrawal allowance. Each policy year, an amount up to 5% of each premium paid can be withdrawn without triggering an immediate liability to tax. Unused allowances carry forward to future policy years. 

These withdrawals are not tax‑free, but tax‑deferred. Any amounts withdrawn are added back into the chargeable gain calculation on full encashment. However, this deferral can be highly valuable where tax is pushed into a later year in which your client pays tax at a lower marginal rate. 

Different taxpayer outcomes and top slicing relief 

When a chargeable event gain arises, it is taxed as income. However, because tax has already been paid within the life fund, the tax outcome depends on the client’s marginal rate of income tax at that time: 

• Non taxpayers cannot reclaim the tax paid within the fund 
• Basic‑rate taxpayers have no additional tax to pay 
• Higher‑rate taxpayers pay tax only on the difference between basic and higher rates 
• Additional‑rate taxpayers pay further incremental tax 

Top slicing relief plays a key role in mitigating the impact of taxing gains in a single tax year.  By spreading the chargeable event gain over the number of completed policy years when determining the rate of tax payable, top slicing can significantly reduce the effective tax rate, particularly where the full gain would otherwise push your client into a higher or additional rate tax band, but the annual “slice” does not.  

Wider planning opportunities 

Onshore bonds support wider planning objectives. They are often segmented and assigned without triggering a chargeable event, enabling planning strategies such as intergenerational gifting or funding education costs. 

They also work effectively with trust and estate planning, care funding strategies and succession planning. Many providers offer a range of trust solutions that can be used to support these objectives, often at no additional cost.   

While offshore investment bonds can also be appropriate for UK‑resident investors, this article focuses specifically on onshore bonds and their increasing relevance in the current UK tax environment. 

A rebalancing of investments, not a replacement 

Onshore investment bonds are not a universal solution, nor should they replace directly held collective investments entirely. Each investment structure plays a role, and the optimal solution will depend on the client’s objectives, time horizon and wider tax position, during the investment period and when expecting to realise capital or income in the future. 

However, in a world of reduced allowances and increased tax exposure, onshore investment bonds have become more relevant.  Their ability to defer taxation, manage the timing of personal tax assessments and integrate with longer -term financial planning makes them a valuable planning tool when used appropriately. 

For advisers, the opportunity is not to favour one investment type over another, but to select the right investment portfolio combination, ensuring that investment solutions are aligned with how and when your client ultimately expects to access their wealth, and their longer-term financial objectives.  

For further information and queries, please call one of our distribution team today, or refer to our TechVoice resources. 

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