Investment bonds are complex investment products. This blog looks in simplistic terms at some of the problems and solutions available both pre and post death.
What are the planning opportunities for owners of investment bonds whilst they are still alive?
Higher Rate Taxpayers – Avoiding Additional Tax on Death
Pre-death, a higher rate taxpayer and owner of an investment bond has a tax planning opportunity that is lost on death. If action is not taken, additional tax may be suffered on death, therefore reducing the inheritance for beneficiaries.
Higher rate taxpayer problem: On death there is no flexibility in terms of tax. If the sole owner and life assured of an investment bond is a higher rate taxpayer (or will be pushed into the higher rate tax band), there will be additional income tax for the executors to pay at a rate of 20%.
Higher rate taxpayer solution: With careful planning, additional tax on death can be avoided. During the investment bond owner’s lifetime they could assign (give away) the investment bond to a spouse or adult child/grandchild who are non-taxpayers or basic rate taxpayers.
The assignment does not create a tax charge (known as a chargeable event), and therefore no tax is liable. The new owner(s) of the investment bond can then surrender (cash in) the bond, and tax will be calculated based on their income (with top slicing relief is available). Provided the new owner is not pushed into the higher rate tax band, there is no further tax to pay.
With careful planning, investment bond owners, who are higher rate tax payers, can avoid additional income tax on death.
Please note, if the new investment bond owner keeps the policy running, it is important to remember that the investment bond will have to be surrendered upon the death of the original life assured.
This solution can also work for jointly owned investment bonds where one or both owners are higher rate taxpayers.
Remember, top slicing relief is only available when the investment bond gain pushes a non or basic rate taxpayer into the higher rate tax bracket.
If an individual who is already a higher rate taxpayer triggers a surrender of an investment bond, the whole gain is added to their other taxable income and additional tax is liable at 20% for higher rate taxpayers (and potentially 25% for those pushed into the additional rate tax band).
Investment bond gains are treated as income and when an individual exceeds £100,000 of income in a single tax year, they begin to lose £1 of their personal income tax allowance for every £2 of income above £100,000.
What are the tax planning opportunities when the owner of an investment bond has died and at least one named ‘life assured’ is still alive?
Estate Administration – Surrender or Assignment
Generally, upon the death of an investment bond owner there are two options for executors provided at least one life assured is still alive. Executors can surrender (encash) the investment bond, or they can assign (give away) the investment bond, typically to a named beneficiary in the Will or family member.
Surrender or Assignment: Often, executors can save tax for the beneficiaries and ensure they hold onto more of their inheritance if the investment bond is assigned and not surrendered. Problems arise when executors decide to surrender an investment bond and pay monies out to the beneficiaries who are then pushed into the higher rate income tax band. The example below explains how this problem occurs.
Bob dies and within his estate sits an investment bond that was setup by Bob on a single owner basis with his wife Alison as an additional life assured. The bond was held for 10 years and upon Bob’s death had made a chargeable gain (profit) £50,000. Alison’s Solicitors, who are executors and administering Bob’s estate, surrender the investment bond. The executors of the estate have no further tax liability and they pay the investment bond proceeds to Alison along with an R185 form. The R185 form details a chargeable event gain of £50,000.
Alison speaks to an accountant and is told she needs to declare the chargeable event gain of £50,000 to HMRC along with her other income for the current tax year. Alison has other income which amounts to £10,000 from a state pension and small private pension. The accountant tells Alison she must pay income tax of £3,000 because her income has significantly increased due to the chargeable event gain as detailed on the R185.
But why does Alison have to pay £3,000 in tax? Alison has a basic rate tax band of £45,000 (including the personal allowance of £11,500). Her total income is now £60,000, which means £15,000 is liable to higher rate tax at 40%. As the investment bond is deemed to have already suffered 20% tax at source, Alison is only liable to pay a further 20% income tax on the £15,000 of income that sits in her higher rate tax band. This is equal to £3,000 (£15,000 @ 20%).
Surrender or Assignment solution: The simple solution to saving Alison £3,000 in unnecessary tax is for the executors to assign the investment bond to Alison (instead of surrounding the bond). Alison can then surrender the investment and benefit from ‘top slicing relief’. This means only £5,000 is added to Alison’s other pension income of £10,000, bringing her total taxable income to £15,000. As this amount sits within the basic rate tax band, and 20% tax has already been paid on the investment bond at source, no further tax liability arises.
Please note: Where more than one beneficiary is entitled, it might be difficult to assign a Bond in the required proportions between the beneficiaries unless it is segmented. This could possibly be overcome by assigning the Bond into a bare trust for the benefit of the beneficiaries although this slightly complicates matters.
THE VALUE OF INVESTMENT BONDS AND THE INCOME THEY PRODUCE CAN FALL AS WELL AS RISE. YOU MAY GET BACK LESS THAN YOU INVESTED.
TAX TREATMENT DEPENDS ON INDIVIDUAL CIRCUMSTANCES. TAX TREATMENT RATES AND ALLOWANCES ARE SUBJECT TO CHANGE.
Please contact us if you would like to discuss your investment bond tax planning opportunities.
TAX PLANNING AND TRUSTS ARE NOT REGULATED BY THE FINANCIAL CONDUCT AUTHORITY.