"With Profits(?)" bond policy - writing into Trust

Trusts Discussion
1

Newly qualified private client solicitor - confused!

Client is an 84 year old spinster. She has an AVIVA Bond where £50,000 was contributed in 2001 (so 23 years ago) under her personal name, and it has now grown to £120,000. There have been no withdrawals, or additions on the policy.

Question - if it is written into trust now with AVIVA’s own trust team (for obvious IHT mitigation) is it considered a PET at the date of the transfer into trust (i.e. now and then 7 years to run) or does the two year (in good health) rule apply that I’ve read about but otherwise charge free, or heaven forbid a CLT payable now, or none of those options?

Further - I am told by AVIVA if it’s just encashed now, then the gain of £70K across the lifetime of the policy is subject to an income tax charge (not CGT) at 20% on all gain above the higher rate bracket of £50,271 (because 20% corp tax has already been paid by AVIVA). Is this “With profits”?

Thanks for your opinions!

2

Assuming the intended trust is a discretionary trust, the assignment to the trustees will be a chargeable lifetime transfer for IHT purposes.

The trust will need to be registered under TRS.

If the bond is surrendered the gain (profit) is charged to income tax. However a basic rate credit is available meaning that your client will only suffer tax on the gain at the excess of her marginal rate over basic rate.

Additionally your client might (depending on her other income) be able to avail of ‘top slicing relief’.

Aviva’s Technical or Legal departments will be able to provide further information on this relief.

3

Agree with the above.

If the sum of CLTs (inc the new bond addition) in the 7 year period is below the nil rate band, there will be no IHT due immediately.

You could consider placing the bond into trust.

With-profits might be. All bonds pay 20% CT therefore the investor is deemed to have paid tax at the basic rate - regardless of the underlying investment.

Youve got the opportunity to encash over two tax years = over the next 3 months. Pre and post April 2024.

Richard C. Bishop
PFEP

4

Richards’s point of spreading the gain over the tax years is worth considering if you are looking at alternative methods of IHT planning other than placing the bond into trust.

Your client’s health and need for the funds are also a factor.

If you choose the trust route the Insurance companies own trust deeds are provided free of charge and although they are generally quite comprehensive it worth checking the wording

Clive Perks
Supportive Financial Planning

5

Thank you to all those who have contirbuted very thought provoking reponses so-far.

It was entirely remiss of me not to mention, she has already made several PET’s well in excess of £325K, and therefore any CLT writing into Trust is immediately chargeable, at 20% I imagine, plus various other headaches.

One’s mind begins to turn to BPR and the numerous providers of AIM investment schemes etc., including some products that even contain an insurance element such that if the policy holder dies within the 2 year qualifying period - the consequent IHT charge is covered…but I guess that’s a conversation for a whole different post.

Fundamentally - a trust option seems not to really fit these facts, but the PET gun has already been fired on other gifts, and if those PET’s work through in the order they were made, any new one made now will take far too long to work through the backlog.

6

Hi Adam

The BPR solutions have their place with or without the life cover and the choice is not straightforward.

The life cover element is written under trust. If they are appropriate, they can be effective, and I have had experience of them working; however, care needs to be taken.

Clive Perks
Supportive Financial Planning

7

You can make a PET by giving one individual, preferably several, on a bare trust for vested but defeasible interests and including a power of appointment which does not override them ab initio but which, if exercised, could do so. The trustees must not be bound to exercise it.They each start off with a pro rata share of the trust fund in their respective IHT estates and they are entitled to any income arising or which would arise if the only trust asset were not a bond. Settlor (but not necessarily spouse) excluded for GROB and POAT reasons.

The power of appointment may never be exercised and, if it is not, then on death their share will be chargeable to IHT. If their share of the fund is distributed to them in their lifetime, no IHT charge as their estate does not reduce in value. Indeed it may increase in value because a defeasible interest is not worth as much as an absolute interest. My view is that there is no “settlement” within s43(2) as persons are not entitled in succession (despite the existence of the power) nor subject to a contingency as the interests are vested and the objects of the power are not within that description of contingent; they have nothing provided the trustees are entirely free not to exercise the power. They are not wholly devoid of rights e.g… they could argue breach of trust if the trustees benefited a non-object.

If the power is exercised an individual whose share was thereby reduced would make a PET if an individual benefited outright under the power, otherwise a CLT. The value transferred is arguably the market value of the defeasible interest before it was extinguished i.e. not much.

This arrangement must not be set up to deliberately to secure some “disappearing value” abracadabra or associated operations, Ramsay, and GAAR may engage. Similarly, however tempting, the individuals with defeasible interests should not be Sir Keir and his Shadow Cabinet members at the date of execution of the document. Some of us remember General Franco schemes in 1975 and pious retrospective counteraction might follow swiftly.

It is always worth considering a foreign bond after evaluating the financial aspects such as comparative yields and security of returns (so also the comparative existence and effectiveness of any foreign regulatory regime). This is because the profit on the bond will be taxable at all rates of tax and the non-resident insurer may have a low local tax charge or none feeding into the return. The BR tax credit on a gain from a UK policy is given on the assumption that the UK insurer will have suffered tax at that rate, whatever the actual position. But the credit is not repayable. So if the chargeable event arises on the living settlor, or can be finessed out gratis to one or more beneficiaries before it is triggered, the settlor or beneficiary may have, or contrive to have, an available PA and/or BR band.

And as Richard indicates it is possible to spread the charge over several tax years e.g. a single gratuitous assignment followed by partial surrenders over 3 tax years spanning 14 months as the crow flies, say on 1 April 2025, 7 April 2025 and 7 April 2026. Four grandchildren each with a PA of £12570 times 3 years gives total tax-free headroom of £150,840 (but only with a foreign bond). Even using a bog standard DT (so no risk of Ramsay or GAAR) will do if the settlor has no cumulation and the CLT is £325k or less. This will allow one or more IHT-free distributions in the first 10 years and possibly modest effective rate charges at the first 10 year anniversary and on later distributions/anniversaries depending on original premium and investment growth. Some of my former clients have grandchildren in double figures!

Jack Harper

8

PETS made in the previous 7 years have the potential to be exempt so are not included in the lifetime CLT calculation. She might have made a PET for £1m last week but she can still put up to £325K into a discretionary trust without an immediate 20% IHT charge. But if she does die within 7 years the IHT will need to be recalculated.

Just also check whether the Aviva bond is segmented. People have commented about surrendering over tax years which is a good planning tool but if the bond is not segmented then you are into the partial surrender chargeable events (5% allowance).

Kim Jarvis

9

But if she dies and the PET fails what is the effect on the RPT? See IHTM42255. Surely she would have been better advised to make the CLT first and the £1m PET later

Jack Harper

10

In an ideal world yes the order of gifting should be CLTs then PETs but I was just highlighting Adam’s comment that “she has already made several PETs well in excess of £325K, and therefore any CLT writing into Trust is immediately chargeable at 20%” - that wasn’t right as the PETs already made have no impact on the lifetime CLT cumulations.

Kind Regards
Kim

11

You’re right to question the “With Profits” moniker.
That internal rate of return is equivalent to approximately 3.87% per annum during a period when inflation (RPI) has averaged 3.52% per annum. There has, therefore, been no meaningful increase in purchasing power.
The world’s capital markets have (as usual) delivered returns of 6% to 7% per annum but these have been eaten up in the smoke and mirrors that is “with profits”

12

Thanks Kim - you are quite right. The PET’s I mentioned already being made are not relevant to the CLT (up to a value of £325K going into trust), because as you rightly say the donor has not died yet, save that because the settlor is 84 already and actuarially unlikely to live 7 years, those PET’s will have an impact surely when they are cumulated into the £325K being contemplated into trust now. What Jack refers to at IHTM42255 with the PLCT has the net effect that after it is all cumulated there’s just not much financial benefit (quite aside from administrative effort) to running the trust.

Once the settlor’s £325K (for that is the only band she has available being a spinster) is used - it’s used whether its for a PET, an entry into a Relevant Property Regime trust, or a failed PET cumulated into the trust setup or added to a CLT on a trust set up. That’s why I’m searching around for things like the BPR exemptions (see posts above) etc.

Unless she could marry her intended beneficiary (at the age of 84!) I cannot see any quantitavely meaningful routes.

13

Id suggest you’d have some attiude to risk issues placing an 84 year old in AIM funds. The FTSE100 AIM is currently -15% 1Y

It would be an intetesting client meeting :unamused:

Richard C. Bishop
PFEP

14

And I should of course point-out, that as a solicitor, at no-stage will I be offering financial advice! We can assist with advice relating to the application of law, but all purchases of investments are arms-length through regulated professionals.

Just to make that clear!

Thank you all for your timely and informative responses. I have learnt new things, and there’s plenty to digest.

15

For those less familiar with investment bonds, there is a distinction between:
(a) a partial surrender of the bond (ie a surrender or release of part of the value from each of the segments of the bond)
and
(b) a full surrender of part of the bond (ie a surrender or release of all of the value from only some of the segments of the bond.

I won’t go into the detail of this, but most of the discussion thus far has considered option B - a full surrender of some or all of the segments. With “partial surrenders” (option A), it becomes much more complex, and you can run into unexpected tax charges, if you are not careful.

In particular, where you make a partial surrender of a segment (beyond the available 5% annual allowances - NB 5% of the original invested amount), the gain which is treated as arising on the partial surrneder is treated as arising at the end of the “policy year”, which is unlikely to tie in exactly with the tax year. The “policy year” is typically the year which runs from the date on which the bond is created. Therefore, if you make two partial surrenders of the same segment during the same policy year, they are both deemed to have arisen at the end of the policy year - in fact, one waits until the end of the policy year to see what gain is treated as having arisen as a result of the partial surrenders. That “policy year end” is effectively brought forward is the balance of the segment is surrendered in full.

For example: suppose the policy year runs from 1st July to 30th June the next year and a partial surrender was made on 1st April 2023 and another on 7th April 2023: we then roll forward to 30th June 2023 and work out what gain is treated as having arisen on 30th June 2023 as a result of those two partial surrenders. If a further partial surrender is to be made, in April 2024, it will be deemed to arise on 30th June 2024, regardless of whether the partial surrender in 2024 is made on 1st April or 7th April.

A full surrender, on the other hand, triggers a gain (if there is a gain) on the date of the surrender and any partial surrenders which have happened during the policy year up to the date of the full surrender are treated as arising on that date.

There is a very useful guide on the M&G website:

Paul Davidoff
New Quadrant

16

This is a most valuable contribution by Paul. Segmentation facilitates the the spreading of full surrenders. This avoids the terrible predicament of poor Mr Lobler who made a partial surrender and suffered an unexpected (for him) catastrophic gain which the UT put right by a Nelson’s touch grant of rectification as HMRC shed crocodile tears. Now corrected by legislation.

It emphasises that this sort of care this planning requires and that it is essential to work with the insurance company. My experience of this has been invariably excellent, provided you get through to the right people, who are true experts in the tax and related law (and won’t charge you!).

Do not allow yourself to be fobbed off by an Erk at the insurer. Such a one rejected my change of trustees deed as it was not signed by all the parties. I pointed out that it was signed in counterparts and had (though not strictly necessary) an express clause to that effect. I was called back by one of the aforesaid right people who confirmed acceptance. Soon the Erk will be replaced by AI.

It also means that the policy contract is an integral part of the structure e.g. as Kim Jarvis pointed out recently https://trustsdiscussionforum.co.uk/t/waiving-discounted-gift-trust-withdrawals/21169. The terms and conditions may restrict room for manoeuvre.

To be fair, I have not had much cause to criticise the company’s standard form trusts but it must be borne in mind that they are just that. It is not clear to me what legal responsibility insurers have for them but long usage probably means that they have withstood any risk on their part.

Punters should at least pay for legal advice on whether one will do the job they want it to do and a full blown customised trust deed is not always necessary. Although insurers provide them free (at the point of sale at least) they are not going to provide a free explanation of how the executed trust (and, in conjunction, policy) might be managed as the future’s most likely personal scenarios unfold. I do not like to be too pious here as Punters’ myopic false economy was always good advisory business (Kerching!).

Jack Harper

jack:

partial surrenders over 3 tax years spanning 14 months as the crow flies, say on 1 April 2025, 7 April 2025 and 7 April 2026

For those less familiar with investment bonds, there is a distinction between:
(a) a partial surrender of the bond (ie a surrender or release of part of the value from each of the segments of the bond)
and
(b) a full surrender of part of the bond (ie a surrender or release of all of the value from only some of the segments of the bond.

I won’t go into the detail of this, but most of the discussion thus far has considered option B - a full surrender of some or all of the segments. With “partial surrenders” (option A), it becomes much more complex, and you can run into unexpected tax charges, if you are not careful.

In particular, where you make a partial surrender of a segment (beyond the available 5% annual allowances - NB 5% of the original invested amount), the gain which is treated as arising on the partial surrneder is treated as arising at the end of the “policy year”, which is unlikely to tie in exactly with the tax year. The “policy year” is typically the year which runs from the date on which the bond is created. Therefore, if you make two partial surrenders of the same segment during the same policy year, they are both deemed to have arisen at the end of the policy year - in fact, one waits until the end of the policy year to see what gain is treated as having arisen as a result of the partial surrenders. That “policy year end” is effectively brought forward is the balance of the segment is surrendered in full.

For example: suppose the policy year runs from 1st July to 30th June the next year and a partial surrender was made on 1st April 2023 and another on 7th April 2023: we then roll forward to 30th June 2023 and work out what gain is treated as having arisen on 30th June 2023 as a result of those two partial surrenders. If a further partial surrender is to be made, in April 2024, it will be deemed to arise on 30th June 2024, regardless of whether the partial surrender in 2024 is made on 1st April or 7th April.

A full surrender, on the other hand, triggers a gain (if there is a gain) on the date of the surrender and any partial surrenders which have happened during the policy year up to the date of the full surrender are treated as arising on that date.

There is a very useful guide on the M&G website:
https://www.mandg.com/pru/adviser/en-gb/insights-events/insights-library/taxation-uk-investment-bonds?utm_source=legacyurls&utm_medium=301&utm_campaign=/knowledge-literature/knowledge-library/taxation-uk-investment-bonds/

Paul Davidoff
New Quadrant

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Previous Replies
And I should of course point-out, that as a solicitor, at no-stage will I be offering financial advice! We can assist with advice relating to the application of law, but all purchases of investments are arms-length through regulated professionals.

Just to make that clear!

Thank you all for your timely and informative responses. I have learnt new things, and there’s plenty to digest.

17

Good points above.

For the avoidence of doubt if implementing Jacks excellent muti-year strategy - “surrender of full segments” is how you encash an onshore UK investment bond.

Encashment across all segments or part surrenders will typically result in a higher tax burden and should be avoided in terms of planning.

Richard C. Bishop
PFEP