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Investment bond

Replacing the investment bond in an existing trust

Over the years there have been many investment bonds written in trust, in most cases using the life company’s standard trust form.

But it may be the case that the trustees have decided that the existing investment is unsatisfactory and want to replace it with an investment bond provided by a different life company.

Of course, there has to a good reason for doing so and, according to trust law, it must be in the best interest of the beneficiaries. It might be that the current investment is unsatisfactory and there is no acceptable alternative amongst the investment links available from the existing provider.

This is more likely to be the case where they are a ‘zombie’ life company, perhaps closed to new business, with no interest in providing an up to date fund range.

Importantly for the trustees, they should make sure that they take professional advice (as well as comply with legislation) to confirm that is the case.
If they decide to go ahead and cash in the existing investment bond for reinvestment elsewhere, all trustees have to sign the surrender form so must be in agreement about the course of action they are undertaking.

In addition, they must have the powers to deal with the investments in this manner, but following the Trustee Act 2000 (or the Scotland and Northern Ireland equivalents) even if the trust provisions do not expressly include these, they can still proceed. But before acting, the trustees should ascertain if there will be a chargeable gain on surrender. This could occur even if the value has dropped, because any previous partial withdrawals have to be added back on surrender.

For example, say a £100,000 discounted gift trust with £5,000 yearly withdrawals is worth £80,000 after six years. On surrender, the chargeable gain is £10,000

(£80,000 + £30,000 - £100,000 = £10,000), because the withdrawals to date of £30,000 are added to the surrender value of £80,000 to assess the overall chargeable gain.

Chargeable gains on policies held under a discretionary trust are assessed on the settlor, if they are alive and UK resident in the tax year of the gain arising. Failing that, or if the settlor is non-UK resident, the UK resident trustees are assessed on the gain. Which is bad news because apart from the first £1,000 at 20%, the gain is taxed at 45% (it would be nil and 25% respectively for a UK bond). And there would be no top slicing relief available to the trustees.

If the trustees are not UK resident, any UK beneficiary benefiting from the gain will be assessed. So if the settlor is still alive and it is a UK bond, with the top slice falling into their basic rate tax band and no personal allowances being compromised, no tax will be payable on the surrender.

But the trustees should be careful if there was, because the settlor can claim back the tax paid from the trustees. This would be highly unusual and probably pointless, but an assurance should be sought that a claim will not be made before the proceeds are reinvested.

The question of who the surrender cheque should be made payable to is very relevant. In most cases, a trustee bank account would not have been needed (as it was just an investment bond holding) and to open one just to deal with the cheque is an unnecessary complication.

Hopefully, the existing provider could make the cheque payable to the new provider or the trustees could delegate payment to one of them. That trustee could then demonstrate that they were just facilitating the trustee investment and there was an audit trail showing the track of the trustee investment backed up by minutes of the trustees’ decision.

This is important as you would not want the proceeds to leave the trust and re-enter it, starting the seven-year inheritance tax clock all over again. From an adviser’s point of view, any trail commission would end and be replaced with an ongoing adviser charge, which will count against the 5% withdrawal allowance.

There are also specific points to note if it is not a standard gift trust or flexible trust.

Gift & loan trusts

It could be the case that all or some of the interest-free loan is still outstanding. As this was a separate agreement, it is not affected by the trustees changing the assets held. However, the amount of the new investment that comprises the existing loan and the amount that comprises investment growth should be noted by the trustees.

The chargeable gain on the surrender of the existing bond reflects the investment gain, but it is the settlor who is assessed when they cannot benefit from it. Although any income tax bill does have the effect of reducing their estate for inheritance tax! As mentioned above, the settlor could reclaim the tax from the trustees if they really thought it worthwhile.

Discounted gift trusts (DGTs)

One issue is whether the trustees can actually surrender a discounted gift trust. Since March 2004, with the advent of pre-owned assets tax, some companies’ DGTs are carved-out at policy level and not surrenderable.

But if it is capable of being surrendered, then it is vital that the agreed level of income in the original trust continues, irrespective of the current investment value.

This can lead to an excess over the 5% withdrawal allowance, especially if an ongoing adviser charge is being taken.

Say that Mr Ashley invested £100,000 in a DGT but, due to poor investment performance over the years and the drain of the 5% withdrawals, it is now worth £80,000.

The provider did not offer open architecture and the range of funds was poor, so after discussions with his adviser, Mr Ashley and the other trustees decided to cash in the investment bond held by them and reinvest in an open architecture investment bond.

This was allowed under the policy conditions and trust provisions. Although there was some tax payable on the chargeable gain, Mr Ashley decided to pay it rather than reclaim it from the trustees and reduce his beneficiaries’ fund.

But the withdrawals must still be £5,000 yearly under the new bond as this was embodied in the trust arrangement at outset. This equates to an annual withdrawal of 6.25% of the amount invested in the new bond, so an excess chargeable gain of £1,000 (1.25% of £80,000) will arise every year in future.

There will be a basic rate tax credit for a UK bond, but if the trustees buy an international bond there is likely to be a tax liability of at least 20% each year for the settlor. This amounts to £200 in this example as the excess gain is £1,000 each year.

On the other hand, Mr Jeffries also invested £100,000 in a DGT with a 5% withdrawal and because his bond experienced better investment performance it is now standing at the same value.

If he were to reinvest in a new bond the rate of withdrawal will have to be maintained and the ongoing adviser charge of 0.5% that is necessary for his adviser to be paid for ongoing investment management services will be treated as an additional withdrawal, causing an excess chargeable gain every year.

All these issues should be taken into account most carefully, before advising trustees about a change of investment bond provider.

It is right and proper that trustees are proactively monitoring, on a regular basis according to legislation, the appropriateness of their investments, but the consequences of changing have to be fully understood beforehand.

This briefing note has been prepared for professional adviser use only.

 This briefing note is also available as a PDF.

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