Just over seven years ago my mother put a bond, which is now worth £80,000, into a bare trust in equal shares for her five grandchildren with a view to avoiding inheritance tax (IHT). She is still alive.
She and I are trustees, and both agree that the grandchildren (now aged between 24 and 30) would benefit from the money now rather than waiting for her to die. All of them are working and paying basic income tax but only one is a higher-rate taxpayer.
Is there any tax or other financial advantage to waiting until she dies before giving them the trust money? It is possible that by then all may be higher-rate income taxpayers.
My mother is wealthy and her estate is well above the current IHT allowance.
As the beneficiaries of a bare trust, the grandchildren have an absolute entitlement to the trust assets and income. They will therefore be liable for any tax due as if they owned the bond themselves. This would be the case whether the bond is cashed in now or on their grandmother’s death. So in that sense it makes no difference when they receive the money.
They also have the right to take actual possession of trust as they are over 18. This means it would be possible for the trust to assign each one’s share to them. They could then make their individual decisions about whether to keep their share or take the money.
An investment bond is regarded as a non-income-producing asset. An income tax charge only arises when a so-called chargeable event occurs and there is a chargeable gain – essentially the difference between the surrender value and the initial investment. Full encashment is one such chargeable event.
Chargeable gains are not liable to basic-rate tax. The individual or trustee who is liable for tax is deemed to have already paid tax at the basic rate on the amount of the gain. This is because the underlying funds in the bond are subject to UK life fund taxation. Therefore, the four basic-rate taxpayers have no further tax to pay on the gain. The one higher-rate taxpayer would pay an additional 20%.
However, the four grandchildren who pay basic-rate tax may still have to pay additional tax if the gain would take their income above the higher-rate threshold
This is determined by dividing the gain by the number of complete policy years and notionally adding the resulting figure to their other taxable income.
One option to consider is partial encashment. Up to 5% of the initial premium can be withdrawn without any immediate tax charge. There may be an additional charge if the bond is eventually wholly cashed in – this will depend on the individual’s tax status at that time. Assuming the bond has been held for seven full years, each of the beneficiaries could withdraw 5% of their share (£16,000) for each of those seven years. That is £5,600, with no immediate tax charge.
Your primary responsibility as trustees is to act in the best interests of all beneficiaries. This must be taken into account in any decision you may reach and that may mean treating each beneficiary separately rather than making blanket decisions for all five.
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