Investment bonds are popular investments for tax planning and in particular estate planning because of the unique way in which they are taxed. Investment bonds are taxed under UK life insurance taxation legislation because they are technically life assurance policies issued by insurance companies. How can that be so?

 

Well, it’s because if you give investment bonds their true technical name then they are single premium non-qualifying whole of life assurance policies and there’s the rub. They come under the definition of life policies because they offer a notional amount of life assurance, usually 101% of the value of the bond on surrender (encashment) though it is possible to increase the life assurance element if allowed under the terms of the policy. Investment bonds are only subject to one form of taxation, Income Tax, on so-called chargeable events. So no Capital Gains Tax. It is also possible to avoid or delay Inheritance Tax (IHT) by, for example, putting the bond into trust.

 

 

There are so-called onshore and offshore investment bonds. Onshore bonds are bonds issued by UK resident insurance companies such as Aviva, Prudential and AXA. Offshore bonds on the other hand are issued by non-UK resident insurance companies in tax havens such as The Isle of Man, the Channel Islands or the Dublin Financial Services Centre usually by associated companies of these well known UK insurance companies.

 

Onshore bonds are deemed to have borne basic rate taxation (20%) at source whereas offshore bonds suffer little if any taxation at source other than a very small amount of withholding tax on certain overseas dividend receipts.

 

A major advantage of such bonds, especially the offshore ones, is the ability to defer Income Tax for potentially very long periods of time, often decades.  This is usually achieved by taking advantage of the 5% rule. Tax deferred withdrawals of up to 5% p.a. of the original investment amount may be taken for up to twenty years without incurring a tax charge.

 

Bonds have policyholders, owners, and lives assured. Typically the parents are the policyholders and live assured and their children are usually appointed as additional lives assured. With offshore bonds, you can potentially add more lives assured including grandchildren.  The reason for appointing younger lives assured is to increase the investment term of the bond by delaying a potential tax charge when the last of the lives assured dies. The younger the lives assured potentially the longer the bond will last without triggering a chargeable event and a possible tax charge on the death of the last of the lives assured. However, chargeable events can happen much earlier than expected for example in the event of premature family deaths. This is where Capital Redemption Bonds have a part to play.

 

 

So, what is a Capital Redemption Bond? Well, it is like an investment bond except for two significant differences. There are no lives assured and it has a maximum term of 99 years.

 

So, if the owner/s die the Capital Redemption Bond (CRB) does not trigger a chargeable event, a potential tax charge, and it doesn’t have to be encashed. It can remain invested for 99 years. So it is excellent for long term tax planning and intergenerational wealth transfers. Below are some of the features of a CRB:

  • If the owner is tax resident in the UK, then there is no chargeable event, possible tax charge, on that person’s death and the policy does not expire.
  • Because there are no lives assured there is more flexibility for gifting the bond to beneficiaries from a trust or via a Will.
  • There may be difficulty in naming lives assured and in obtaining their agreement to it.
  • When the CRB is fully or partly surrendered the owner has flexible options over the timing of where and when tax charges may arise. This could be achieved by delaying encashing the plan until the owner is in a more tax friendly country or is in a more beneficial tax position by gifting it to another beneficiary or waiting until they are in a more tax friendly jurisdiction.
  • CRBs are more suitable for trusts and companies seeking to lengthen the life of the investment due to there being no lives assured.
  • A CRB is very useful for estate planning by gifting in full or partially to other policyholders or to non-domiciled UK tax residents because it is treated as excluded property for IHT purposes.

 

 

So Capital Redemption Bonds are appropriate investments under the right circumstances and are worthy of serious consideration, especially for long term investment and as a tax efficient vehicle for trusts and companies. You know it makes sense.*

 

*RISK WARNING

The value of investments can fall as well as rise. You may not get back what you invest. The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. The Financial Conduct Authority does not regulate tax planning, estate planning, or trusts.  This blog is based on my own observations and opinions.  

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