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The Name’s Bond (But What Are Bonds?)

In the world of the silver screen there can only be one Bond. James Bond.

But when it comes to financial services it is less clear. Such is the extent of jargon in the world of financial services the word ‘bond’ means different things to different people.

There are:

  • Savings Bonds
  • Government Bonds
  • Corporate Bonds and,
  • Investment Bonds

Savings Bonds

People tend to be most familiar with savings bonds, particularly if they have products with National Savings & Investments. Savings bonds are simply a savings account with a fixed term; typically 1, 2, 3 or 5 years.

They are not limited to NS&I, most high street banks will offer a range of them, and provide a fixed interest rate throughout the term of the bond. When it matures you have the choice of rolling it over to a new term at a different rate or withdrawing the capital with the accrued interest.

The current interest rates are pretty derisory but they provide a secure home for any money you don’t need to have immediately available and don’t want to risk the chance of the value falling.

However, saving too much for too long in a savings bond is likely to mean that this portion of your wealth is loses money in real terms when allowing for inflation.

Government Bonds

More jargon alert! Government bonds are also referred to as Fixed Interest Securities and Gilts (because the early certificates were gilt-edged). If you have a pension for Share ISA you are probably investing in government bonds to some extent.

A government bond is a loan by investors to the government (UK, US or any government around the world) in return for a fixed interest payment (hence the other name) and the promise of a return of capital at the end of a fixed term. If the government wants to raise capital it can either tax the population more (which doesn’t win many votes at elections) or it can borrow the money, which is easier and in the current low interest rate environment relatively cheap too.

Think of it like you or I having a mortgage except that the amount of borrowing by the British government runs to billions of pounds rather than tens or hundreds of thousands of pounds. A global banking crisis followed by a global pandemic hasn’t helped.

Corporate Bonds

Corporate bonds are similar to government bonds except that, as the name implies, they are loans to companies rather than governments.

As much as the likes of Amazon, Apple, Google and co would love to be able to tax their customers, they don’t have that much power. Instead, to raise capital to fund their growth they can either give away shares (by listing on stock markets) or they can borrow from investors like you and me via our pension funds and Share ISAs.

I’ve recorded a video explaining government and corporate bonds in more detail HERE.

Investment Bonds

An investment bond is, as the name implies, a type of investment so should be considered a medium to long-term investment.

Unlike savings, corporate bonds and government bonds, which are different assets classes, investment bonds are a type of wrapper. That is, they are an investment vehicle like a pension or ISA in which you can invest in different assets.

Investments are made as a lump sum rather than through regular contributions and the original capital plus any growth is available to withdraw at any time.

A specific feature of investment bonds is that it is possible to withdraw 5% of the original investment value each year on a tax-deferred basis. When the bond is fully encashed or if an amount greater than 5% of the original investment is withdrawn in any year it is deemed to be a ‘chargeable event’ which may result in an income tax charge.

Whether income tax is payable depends upon the size of the gain, the number of years the bond has been held for and other income received in the tax year of the encashment.

Investment bonds are also referred to as Life Assurance bonds (I did say the world of financial services is full of jargon). This means it contains a (very) small element of death benefit; typically 1% or less of the value of the original investment. This has little benefit over a term assurance policy but it does have a key benefit for care home fees; because it is defined as a life assurance product and not an investment (I know I said it is a type of investment in the first sentence) local authorities can’t include it in a person’s wealth when assessing their qualification for care funding.

The other popular use for investment bonds is within discretionary trusts. Any income received within a discretionary trust is charged at the highest rate of income tax (45%) and have half the standard personal allowance (£6,000 pa). So, because investment bonds provide a return of capital rather than an income they can be invested in by trustees without incurring an annual income tax charge.

So, one term, four different meanings and no gadgets, fast cars or beautiful women.

 

 

Photo by Gift Habeshaw on Unsplash