Investment Bonds in Trust Taxation

Investment bonds can offer clients opportunities for tax efficient wealth management. When these bonds are held in trust, this can provide additional advantages, making them an attractive option for the management of inheritance tax and the transfer of wealth. This article delves into the role of trusts and investment bonds in wealth management and estate planning.

Understanding Trusts

Trusts are legal arrangements where one party (the settlor) transfers assets to another party (the trustee) to manage for the benefit of a third party (the beneficiary). They can provide a solution when an individual wishes to make a transfer for the benefit of others but cannot make an outright gift. Placing assets in a trust can support inheritance tax planning, as this reduces the value of the estate for IHT purposes.

When a trust is created, trustees are appointed to manage the assets for the beneficiaries. If the settlor wishes to retain some influence over the trust fund, they can be one of the trustees, alongside friends, family, or legal representatives. Trusts that offer flexibility regarding who benefits and when are typically called discretionary or flexible trusts.

The type of trust chosen should be determined by the degree of control and access required by the individual.

Attractive Features of Investment Bonds for Trust Investments

A UK or offshore investment bond can be an appropriate asset to be held in trust. An investment bond is a single premium life insurance product used mainly for investment. It allows individuals to invest a lump sum in various funds, with growth potential over time. While it includes a life insurance element, its main appeal lies in its investment capabilities.

Investment bonds have unique tax features that make them attractive for trust investments.

• Non-Income Producing: Investment bonds are non-income producing, meaning that they do not generate regular income, such as interest or dividends, which would be subject to income tax. Trustees do not need to formally accumulate income or complete annual tax returns. This simplifies the administrative burden on trustees and reduces potential tax liabilities.

• Capital Gains Tax Exemption: Unlike assets such as property, unit trusts, or shares, investment bonds are not subject to capital gains tax. This means that assigning an investment bond to a trust by way of gift or from a trust to a beneficiary does not create a chargeable event or tax liability. This makes it easy to transfer an existing bond to a trust and distribute the trust fund to the intended beneficiaries without incurring additional taxes.

• Flexibility in Fund Management: Because bonds are not subject to capital gains tax for the investor, trustees can switch funds without tax consequences. This allows them to respond to market conditions and changing requirements of beneficiaries without tax penalties. This flexibility is particularly beneficial in managing the trust's investments effectively.

• Unique Bond Features: Investment bonds offer unique features such as the 5% tax-deferred withdrawal facility and the ability to assign plan clusters to beneficiaries without a chargeable event arising. These features provide trustees with several options for mitigating tax on the distribution of the trust fund. For example, trustees can make withdrawals up to 5% of the original investment each year without immediate tax liability, allowing for tax-efficient distributions to beneficiaries.

Taxation of Investment Bonds in Trusts

In addition to the features above, an investment bond, held in trust, can provide more options when it comes to wealth distribution and the management chargeable events.

A chargeable event for an onshore investment bond is triggered if the bond is fully cashed in, withdrawals exceed the 5% annual allowance, or the life assured dies (along with several other scenarios).

Taxation against the settlor’s position

When a chargeable event occurs with a bond held in trust (except for an absolute/bare trust), the gain is assessed based on the settlor's tax position if any of the following conditions are met:

• Settlor is Alive and Resident in the UK: If the settlor is alive and living in the UK at the time of the chargeable event, the gain from the bond is assessed based on the settlor's tax position. This means any tax due will be calculated according to the settlor's income tax rates and allowances.
• Death of the Settlor: If the chargeable event is the death of the settlor, and the settlor is the sole or last surviving life assured, the gain is assessed based on the settlor's tax position.
• Surrender in the Same Tax Year as Settlor's Death: If the settlor has died, but the trustees surrender the bond within the same tax year as the settlor's death, the gain is still assessed based on the settlor's tax position.

These conditions ensure that the tax liability is calculated using the settlor's tax situation, potentially benefiting from their tax allowances and rates. Top-slicing relief can also be used to reduce the tax on the gain.

Taxation against the trustees

In other cases, the chargeable event gain is assessed on the trustees at the trust rate of 45% (unless they are non-resident), with a credit for basic rate tax if the bond is an onshore bond.

• Trust Rate: Trustees are responsible for paying tax on income and the chargeable event gain received. The tax rate is 45% for all income (except dividend-type income, which is taxed at 39.35%).
• Onshore Bonds: For onshore bonds, there is a credit for basic rate tax. This means that the basic rate tax (currently 20%) is considered to have already been paid on the bond's gains. Therefore, the trustees would only need to pay the difference between the basic rate and the trust rate, effectively reducing the additional tax liability to 25%.

Taxation against the beneficiary

If the trustees assign the bond to a beneficiary before cashing it in, the beneficiary can cash it in themselves. This can be beneficial if the beneficiary has a lower tax rate, as they will pay less tax on the gain. Additionally, they can use top-slicing relief to further reduce their tax liability.

Essentially the investment bond, held in trust, provides more flexibility around how the funds are accessed in a tax efficient way, based on the tax position of the settlor, trustee and beneficiaries.

Conclusion

Investment bonds held in trust offer a powerful combination of tax efficiency, flexibility, and protection for both trustees and beneficiaries. By leveraging features such as non-income production, capital gains tax exemption, and the ability to make tax-deferred withdrawals, trustees can effectively manage and distribute trust assets. Understanding the taxation rules and strategic use of investment bonds can help trustees minimize tax liabilities and maximize the benefits for beneficiaries. This makes investment bonds valuable for comprehensive estate and financial planning.