As soon as Alistair Darling announced in his Pre-Budget Report that capital gains were going to be taxed at a flat rate of 18 per cent, the insurance industry reacted with a flurry of activity centred on why investment bonds should still be considered as the investment of choice.

Not all bad

There are some situations when an investment bond is the right product. Being effectively an insurance policy, they are relatively easy to wrap up in an ‘off-the-shelf’ trust for inheritance tax (IHT) purposes, but even here they were dealt a blow by the retrospective extension of the IHT allowance in the Chancellor’s same speech.

However, I think one should treat with suspicion any investment product that combines up to eight per cent commission with surrender penalties of five years or more. The investment landscape changes so quickly, why should any ‘adviser’ think that the answer is to lock their client into something that penalises you if you want to change your mind?

Bond salesmen will tend to hide behind the cloak of medium- to long-term investment when justifying their sale, but the only reason the exit penalties are there is to protect their commission. No doubt they will highlight the number of free switches that can be made within the contract. But it would be fascinating to see research showing how many advisers offer advice on switches from which they don’t get paid.

The income illusion

The other favourite red herring is the promise of five per cent per annum tax-free ‘income’. Taking five per cent tax-free withdrawals each year from a bond is, in fact, no more than your original capital being returned to you in 20 bite-sized chunks.

I met someone recently whose investment had actually done quite well in their bond, but the ‘income’ they were taking had fallen in real terms as a result. They were stuck having to take five per cent withdrawals of their original £30,000 investment, yet the bond had increased in value to £40,000. Their £125 per month withdrawals actually only represented 3.75 per cent per annum on their current investment – hardly a level of return to get excited about. They could ‘rebase’ the bond to the higher amount, but all this tends to do is create another swathe of commission based on the increased fund value.

Penalised for profit

Strangely, some of the worst problems with investment bonds arise if they have actually done well and produced a profit. It becomes extremely difficult to cash the investment in, as the gain is added to your income for that year.

No doubt I will be criticised by those in the insurance industry who have already labelled ‘doomsayers’ such as myself as irresponsible. They are concerned that there will be a stampede for the exit from those bonds that don’t penalise you for wanting your money back, and that some perfectly good and justifiable investments will go by the wayside. This is not what I am advocating.

What I suggest is that, in the light of Mr Darling’s announcement on CGT, it is a jolly good idea to review your existing investment arrangements to see whether they are still right for today’s environment. With the advent of wrap platforms, it is far easier nowadays to invest one’s money so that it does what you want it to do.