Investors are still being sold investment bonds by financial advisers despite the imminent changes to capital gains tax (CGT), which will make them even less attractive compared with unit trusts.

Last year more than £30 billion of investors' money was placed into investment bonds, and it is not difficult to see why sales are continuing when insurance companies, such as AXA, have been offering special commission deals of up to 7.25 per cent.

Officially, investment bonds are single-premium life insurance policies that offer a range of investment funds, including unit trusts, within a life fund wrapper. However, they do not provide much life insurance. They are designed as long-term growth investments for lump-sum investors, but direct investment in unit trusts is normally more tax-efficient and cost-effective.

The debate about the merits of investment bonds versus unit trusts has been raging for years, but the proposed introduction of a flat-rate CGT of 18 per cent on April 6 looks like the death knell for bonds. As bonds are life insurance policies, the life insurance company pays tax at 20 per cent on the income and capital gains before the investor receives a return. Higher-rate taxpayers have to pay a further 20 per cent income tax on any increase in the value of the bond. So the minimum rate of tax that investors pay on bonds is 20 per cent, while higher-rate taxpayers are likely to end up paying 40 per cent.

By contrast, gains on unit trusts and investment trusts will be subject to CGT of only 18 per cent. For this reason, Hugo Shaw, business manager at Bestinvest, the independent financial adviser, believes that existing bond investors should consider their position carefully. Mr Shaw says: “Investors may well be better off surrendering their policies - bearing in mind that this may trigger a tax bill - and relocating to investments outside the insurance bond that can benefit from capital gains tax at 18 per cent.”

Even under the current CGT rules, bonds do not make much sense for most investors, as gains cannot be offset against an individual's annual CGT allowance (£9,200 for 2007-08), whereas they can with unit trusts. Capital losses on bonds cannot be offset aganst future gains either.

There is little doubt that the main reason why investment bonds have gone on selling so well is because advisers usually receive at least double the commission that they receive from sales of unit trusts.

Robert Reid, president of the Personal Finance Society, says: “I have always felt that investment bonds had few worthwhile features. The main driver of sales has undoubtedly been commission. In my view, bonds should not even be considered unless a couple has more than £214,000 to invest, because the first £14,000 can go into Isas and the remainder can be put into a managed portfolio of unit trusts, which utilises their CGT exemptions.”

Another problem with bonds is that the high commission is recouped by the insurance company in higher charges and early redemption penalties if investors want their cash back within five years. A comparison of performance shows the difference that the charges can make. Over the past five years, for example, £1,000 invested in Schroder's UK Mid 250 unit trust was recently worth £2,619, but the same fund held through a Skandia Life bond was worth £2,248. The differences may not be so great if advisers take less commission.

Mr Shaw says that one rationalisation for advisers still selling bonds is that they allow a tax-deferred “income” to be taken, in the form of a 5 per cent withdrawal each year for up to 20 years. But he adds: “Usually this income is funded by an automatic redemption of units, which can be replicated more tax-efficiently by cashing in unit trusts to make use of CGT allowances.”

Investment bonds are also recommended for inheritance tax planning, mainly because insurers throw in the trust documentation “free”. But the same arrangements can be achieved with unit trusts. Paul Wilcox, the chairman of Way Group, the financial planning company, says: “In 90 per cent of cases unit trusts are more tax-efficient and cheaper than investment bonds.”

CASE STUDY

Neil Deakin, of Cheshire, retired from full-time work a little more than five years ago at the age of 56 and asked an adviser how to invest his £108,000 pension lump sum. The adviser recommended that he split the money between investment bonds with AXA, Legal & General, Scottish Equitable and Prudential.

The former IT specialist, left, says: “It wasn't until a year or so later, when I was going through the paperwork, that I discovered that my adviser had made about £7,000 in commission.”

He was also surprised to learn that there were penalties for early surrender, adding: “I discovered the penalties after three years when I was thinking of switching my investments. It meant that I had to wait two more years until I could take out my money and avoid the penalty charge.”

Mr Deakin has since moved his investment to Bestinvest's portfolio management service, which is investing the money in unit trusts, which he now knows are cheaper, more flexible and more tax-efficient than bonds.

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