Investment Bonds & Trusts in Wealth Transfer Strategies

Investment bonds can play a crucial role in wealth transfer strategies, particularly when combined with trusts. This combination offers a way to gift assets while retaining control and access, which is essential for many donors, especially given increased longevity expectations.

The Basics of Gifting

The simplest way to make a gift is outright. However, outright gifts may not always be practical or desirable, especially when the donor needs to retain some control over or access to the gifted assets. This is where trusts, combined with investment bonds, become highly effective.

Trusts and Investment Bonds

A trust can provide a solution when an individual wishes to make a transfer for the benefit of others but cannot make an outright gift. In this scenario, the person making the gift is called the settlor, and the recipients are the beneficiaries. Trusts that offer flexibility regarding who benefits and when are typically called discretionary or flexible trusts.

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.

A UK or offshore investment bond can be an appropriate asset for trustees to hold. Investment bonds shelter the owner (both trustees as legal owners and beneficiaries as beneficial owners) from taxation on income and gains arising from the underlying investments. Taxation occurs at the life fund level, ensuring no tax liability for trustees or beneficiaries until an encashment or withdrawal is made. This arrangement simplifies the trust's tax administration, as there are no capital gains or income to declare until a withdrawal or encashment occurs.

Bare Trusts

Bare trusts provide a straightforward approach where the beneficiary has an absolute right to the trust's assets and income. Typically set up by parents or grandparents for children, bare trusts ensure that the beneficiary gains control of the assets at age 18 (or 16 in Scotland). The simplicity of bare trusts means that once the beneficiary is named, they cannot be changed, and the assets are attributed directly to them, offering a less complex tax regime and potential exemptions for inheritance tax purposes.

Discretionary Trusts

Discretionary trusts are widely used in financial services due to the flexibility they offer. Trustees have the authority to decide how and when to distribute the trust's assets and income to the beneficiaries. This flexibility allows trustees to adapt to changing circumstances and the varying needs of beneficiaries. However, this comes with a tax implication, as assets held in a discretionary trust are not part of any individual's taxable estate, leading to potential entry, periodic, and exit inheritance tax charges.

Loan Trusts

If the settlor wishes to retain control over the trust asset and access to the funds, a loan trust may be appropriate. Under a loan trust, the settlor lends money interest-free and repayable on demand to the trustees, retaining the right to call back the capital lent at any time. This arrangement allows for regular loan repayments to supplement income or the reassurance that if capital is needed, an amount up to the original investment can be accessed.

Under this plan, the settlor’s taxable estate is not immediately reduced, as the outstanding loan remains part of their estate. However, there is no initial transfer of value for inheritance tax (IHT) purposes.

Discounted Gift Trusts

For settlors who want to immediately reduce their taxable estate and are happy to make a “discounted” chargeable lifetime transfer, a Discounted Gift Trust may be more appropriate. This type of trust allows the settlor to receive regular payments while relinquishing access to the capital. The “discount” refers to the reduction in the value of the gift for IHT purposes, reflecting the value of the settlor’s retained right to receive payments.

Benefits of Using Investment Bonds in Trusts

1. Tax Efficiency: Investment bonds provide tax deferral benefits, as income and gains are taxed within the life fund, not at the individual level, until a withdrawal is made.
2. Control and Flexibility: Trusts allow the settlor to retain control over the assets and provide flexibility in managing and distributing the assets to beneficiaries.
3. Simplified Administration: The tax administration of the trust is simplified, as there are no capital gains or income to declare until a withdrawal or encashment occurs.
4. Access to Funds: Depending on the type of trust, the settlor can retain access to the capital or receive regular payments, providing financial security.

Conclusion

Investment bonds, when used in combination with trusts, offer a powerful tool for wealth transfer strategies. They provide a way to gift assets while retaining control and access, ensuring that the donor's financial needs are met. Whether through discretionary trusts, loan trusts, or discounted gift trusts, investment bonds can help achieve tax efficiency, control, and flexibility in estate planning.