Further Information on Investment Bonds

Holding investment bonds in trust

Bonds have often been used as the underlying investment in a trust as they can easily be written under trust. 

There are a number of estate planning bonds available from insurance companies.  The main types are the Gift Trust, the Discounted Gift Trust and the Loan Trust.  These notes are not designed to explain the purpose of these trusts.

Bonds are useful investments for trustees because:

• they are non-income producing investments and exempt from capital gains tax so that minimal declaration is required under self assessment.

• of the 5% cumulative tax deferred allowance per annum for 20 years.

• they can be assigned by way of gift without triggering a tax charge.  For example a bond, or segments of a bond, could be assigned to a basic-rate/non-tax paying beneficiary so that on subsequent surrender the beneficiary’s tax situation determines what tax is due, if any.

• of their ability to provide investment diversification.

There are disadvantages for trustees of using bonds because:

• they cannot utilise the trust’s annual CGT exemption.

• non-tax paying beneficiaries cannot reclaim tax deducted at source.

• they are not suitable where an income interest exists (e.g. a life tenant trust).

• trustees need to be concerned as to whether regular withdrawals from a trust, even below 5%, may be construed by HMRC as an income payment and therefore taxable.  It is important therefore, that any such withdrawals of capital should be irregular.

Assignment of an investment bond

Where a bond is owned by a higher-rate tax payer it is possible to assign the bond to a spouse or child, or indeed any other person, prior to it being encashed.  The advantage of this is that if the new bondholder is not a higher-rate tax payer there may not be tax to pay on the subsequent surrender of the bond when ‘top slicing’ is taken into account.

The assignment must be because of the bondholder’s genuine intention to give the bond to the other person so that they can use the bond for their benefit.  If, for example, the assignment is to the bondholder’s child or children for their use then HMRC is unlikely to have any problem with this. 

If the assignment is to the bondholder’s spouse so that he or she is able to surrender it without suffering a tax charge, and the proceeds are subsequently invested in a new investment in the original bondholder’s name or in joint names then HMRC would contend that the assignment of the bond was not a genuine gift but was merely a sham and an effort to evade tax.

If a bond is assigned for ‘money or money’s worth’ then this is a chargeable event and the person assigning the bond may have to pay income tax on this.  When the new bondholder makes a full or partial surrender of the bond they could be liable for Capital Gains Tax.  This applies when someone other than the original beneficial owner disposes of the bond and that person has acquired the bond for money or money’s worth. 

Assignment can be useful as security for a loan from a bank.  Once the loan is repaid the bond can be assigned back to the bondholder.

Assignment can be useful in connection with divorce.  Following a Court Order the bond can be assigned to a former spouse and the life office will not issue a chargeable event certificate.

Offshore investment bonds

Although there are some similarities, the taxation of an offshore bond is different in certain aspects from a UK (i.e. onshore) bond.

• The taxation of an offshore bond is governed by the tax regime of the territory where the life office is established.  Naturally, most of these offices are set up in places where the income and capital gains in non‑resident policyholders’ funds are not locally taxed.

• There is, therefore, no tax within the fund on an offshore bond and so the funds should grow faster.  This is often referred to as ‘gross roll-up’.   Historically, however, the charges on offshore bonds have been higher than those of onshore bonds which works against this.

• Dividend and other income which the offshore life office receives from other territories may be subject to non‑recoverable withholding tax.  The effect of withholding tax can, however, be minimised by investing for capital growth rather than income.

• The 5% deferred tax facility applies, as does top-slicing.

• Whereas holders of UK bonds receive a 20% tax credit on taxable gains which satisfies any liability to basic-rate tax, there is no corresponding tax credit on gains from offshore bonds.

• The major difference, therefore, is that when the bond is encashed the gain is taxed at the investor’s highest marginal rate with no deduction for basic-rate tax, i.e. 0%, 20%, 40% or 45%.

Investment bonds and care fees funding

The proper use of bonds as part of a balanced portfolio of investments can be beneficial in helping more of the portfolio to survive the damage done by expensive residential nursing care costs.

The Charging for Residential Accommodation Guidelines (CRAG) sets out the basis under which local authorities must apply the means testing system.  The objective of the means test is to determine the extent, if any, to which individuals are required to contribute towards their care costs when care is arranged by the local authority.

Many local authorities have sought to include bonds as assessable assets under the means test, on the basis that the life assurance element is not their primary purpose.

However, the CRAG guidelines make it clear that ‘if an investment bond is written as one or more life insurance policies that contain cashing-in rights by way of options for total or partial surrender, then the value of those rights has to be disregarded as a capital asset in the financial assessment for residential accommodation’.

If a person were to transfer their assets into a bond to deliberately try and obtain assistance for residential nursing care fees from a local authority this would be unlikely to be an effective strategy as it would almost certainly be classified as ‘deliberate deprivation’.  However, by making use of bonds as part of an overall investment plan well ahead of any need for nursing care, the possibility of having them disregarded under a local authority means test could be a valuable additional benefit in later life.

Use of investment bonds by companies

With effect from 6 April 2008, bonds are no longer suitable investments for companies because tax will be charged on the gains which arise each year.

Chargeable event certificates

When a chargeable event occurs the life company must provide a certificate to the bondholder which will show:

Insurers must deliver certificates to HMRC where the gain or gains total more than half the basic rate of income tax limit but may choose to do so below this for administrative simplicity.  Certificates must be delivered to HMRC in all cases of assignment for money or money’s worth.

Links to more information

• Investment Bonds
• Why are Investment Bonds less popular?
• Money Advice Service notes on Investment Bonds
• If you need personal financial advice on Investment Bonds then I am happy to introduce you to Flying Colours Life who have access to independent financial advisers throughout the UK

Important

This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.

Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe My interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.

If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.