In the complex world of investing, it can be hard to understand all the different variations of investment products and how they work. In this article, we aim to help you gain a better understanding of investment bonds: why they are so commonly used in trusts, and why you may wish to consider using an investment bond within a trust.
What is an investment bond?
An investment bond is a single, premium life insurance product that can be used to hold investments; they also have an element of life insurance. It’s important to bear in mind, however, that investment bonds are primarily used for investment purposes rather than for life insurance purposes.
Bonds can be onshore or offshore, and they have slightly different tax treatments, which we will discuss later on in this article.
Investment bonds are commonly used investment wrappers. This is because of their flexibility and their simple administrative requirements, especially when used within a trust.
Why use an investment bond?
Typical investment products are assessable for tax within the trust. If there is a gain on the investment and the trustees surrender part of the investment within trust, a tax return must be completed.
This is not the case with investment bonds, which accrue a 5% tax deferred allowance (TDA) each year. The TDA can be carried forward for the remainder of the bond’s life. This means for every full year that the policy is in force, you can withdraw up to 5% of the initial investment amount, regardless of the current gain or loss on the bond.
If a beneficiary of a trust wanted a withdrawal from the bond, this could simply be done within the 5% allowance without incurring an immediate tax, and no tax returns would have to be completed.
Using the TDA to your advantage
Unlike typical investment products, an investment bond’s 5% TDA builds up each year. It means that if the trustees wish to surrender more than the accrued tax-deferred allowance, then they can do so, and any gains are taxed at the settlor’s marginal rate of income tax.
Investment bonds also allow for segments of the bond to be assigned to beneficiaries. Should the trustees wish to make any distributions to a potential beneficiary over the 5% entitlement, consideration should be given to assigning all or part of the bond to the beneficiary.
In this case, any chargeable gain would be assessed according to the beneficiary’s own personal taxation situation – not the settlor’s, thus reducing the impact of any income tax payable.
As investment bonds don’t produce an income or require a tax return to be submitted, they are also a popular choice for trustees who want to reduce administrative costs for the trust.
Onshore investment bonds
A gain on an onshore investment bond is already seen to have paid 20% tax throughout the fund’s lifetime, and therefore, should the gain made on the bond keep the settlor’s income within the basic rate tax bracket, then there is no further tax to pay on the surrender.
Margret is a UK resident and is the settlor of a trust, which owns an onshore investment bond. Margret has a gross income of £32,000. The trustees decide to surrender the bond within the trust and there is a chargeable gain of £8,000. This gain is added to Margret’s current year’s income, taking it to £40,000. As £40,000 remains within the basic rate bracket of income tax, there is no further tax to pay.
If, however, Margret had passed away in a previous tax year to when the chargeable gain is made, then the gain is taxed at the trust’s rate of tax, which is 45%, and a total of 25% tax would be payable on the chargeable gain. (45% minus 20% tax already paid on the bond.)
Assigning segments of the bond to its beneficiaries would have avoided this increase in tax as any chargeable gain would be assessed according to the beneficiary’s own personal taxation situation, not the trust’s.
Offshore investment bonds
For an offshore bond, there is no tax paid at source, so the full rate would be payable in the event of a chargeable event. To avoid this, segments of the bond could be assigned to a non-taxpaying beneficiary and there would be no tax charge incurred on the bond.
This example is illustrative of how investment bonds can be used in trust and should not be taken as financial advice. For professional financial advice on investments and all other aspects of financial planning, contact us at CTT Private Client.