Insurance bonds could see a surge in popularity if the Chancellor raises the rate of Capital Gains Tax (CGT) in his emergency budget tomorrow, according to financial research company Defaqto.

The new coalition government has already said that CGT will increase to match income tax; George Osborne will announce the maximum tax rate – thought to be either 40 or 50 per cent – tomorrow. Analysts are also predicting that the annual exemption below which no CGT is paid will be cut from £10,100 to £2,500.

Defaqto is predicting that as a result of possible CGT changes, insurance bonds, which have different taxation rules from direct investments into shares or unit trusts, will become more popular with investors.

Insurance bonds, or investment bonds, are single premium whole of life insurance policies whose prime aim is for investment.  Mainly available through life assurance companies, insurance bonds enable investors to gain access to an extensive range of investment funds. They offer flexibility as there is no fixed term and additional capital can usually be invested at any time and can be particularly useful to those who are currently higher rate taxpayers.

But most importantly, in terms of CGT changes, investment bonds enable investors to take regular withdrawals of up to 5% per annum of the amount invested with no further liability to basic rate tax.

David Abbis, author of the guide and Insight Analyst for Wealth Management at Defaqto says that insurance bonds have suffered in the last two years, mainly because of the change in CGT in April 2008 which made investments in mutual funds more attractive, but if CGT rules change again, says he expects to see resurgence in popularity.

“Changes to CGT which are likely to be announced in the Budget next week include an increase in the current rate and a reduction in the exemption threshold could prompt significant outflows from mutual funds into insurance bonds,” he said.

“Insurance bonds are life policies so the underlying funds are subject to different taxation rules than a direct investment into shares or unit trusts. For example, withdrawals of up to 5% of the original capital amount are permitted each year without incurring any tax liability.”

©Fair Investment Company Ltd