Discounted Gigt Bond: Tax after death

[dsforrester]

My mother (75) is thinking of taking out a discounted gift bond/trust, but there seems to be some unclarity on the tax position if there is additional capital once she has died. Assuming that she takes 5% 'income' off the gift, but that the investment return is above 5%, the trust as a whole will appreciate in value. My understanding is that the trustees are liable to income tax on the excess once the trust is wound up. Since the trust is supposed to help pay IHT on death this is going to happen shortly after my mother passes away. What is the exact tax situation for the trustees?
For example, if my mother invests 100,000 and takes an 'income' of 5,000, but the bond returns 7%, there would be some 127,000 in the trust after 10 years. If she then died, the original 100,000 is outside of IHT, but cashing the bond would trigger a chargeable event. What is the tax situation?

Regards

DSF

[Arnold Aaron]

Hello.

The general tax position is as follows:

Any profit (over the 5% withdrawals) is assesed when the trustees cash it in after death. However, to avoid trustee tax, make sure the trust is wound down first, by assigning the investment bond to the beneficiaries. This should be free of charge.

The policy is now owned by the beneficiary(ies), and not the Trustees.

Tax payable by the individual depends on whether they are personally a higher rate tax payer or not (or near it).

Take the profit that is being surrendered from the policy, and divide by the number of years the policy has been in force. Then add this figure to the beneficiaries taxable income in the year of surrender. If the resultant figure takes the total income above the higher rate threshold, take this excess figure over Higher rate threshold, and multiply it back by the number of years policy has been in force.

The tax liability is ONLY 20% on this resultant figure.

As you can see if the beneficiary is a non tax payer, or not near the higher rate threshold, there should be no tax to pay.

Last point - most important - Tax on the 5% withdrawals taken by the settlor (assuming profit on the whole policy) only comes into the calculation WHEN the policy is fully surrendered.

The investment bond provider will give the figures of any gain, when any partial or full surrender is made.

So, if you leave say £500 and surrender the rest, you have liquidated most of the capital/profit, but avoided paying tax (if an applicable as above) on the 5%'s taken by the settlor during their life, because a full surrender has not taken place. Sadly, this is rarely pointed out by advisers, resulting in unnecessary tax bills.

I appreciate this explanation may be long winded, so If I can be of more help, don't hesitate to get in touch.

regards,

Arnold Aaron
Financial Planning Consultant
Partner, Openwork LLP.
www.arnoldaaron.co.uk
Contact: 07957 440 724
[Specialising in Discounted Gift Trusts for Inheritance Tax planning, and investments]

[Arnold Aaron]

...

so in conclusion to your question,

assuming worst case scenario beneficiary is already a higher rate tax payer if the bond is partially surrendered leaving say £1,000 in the fund, tax is just the £27k profit, at 20% = £5,400.

[Because beneficiary is already a higher rate tax payer, no need to divide by number of years as in my previous posting]

AND, if you are not advised well...

and the bond is fully surrendered after 10 years, take £127k left in the fund PLUS 10 years of withdrawals (£50k) = £177k.

£77k profit, again assuming worst case scenario, beneficiary is a higher rate tax payer, (so no need to divide by number of years) the tax to pay is 20% of £77,000 = £15,400.

Hope that illustrates the point,

regards,

Arnold Aaron
Arnold Aaron
Financial Planning Consultant
Partner, Openwork LLP.


www.arnoldaaron.co.uk

e mail: arnold.aaron@openwork.uk.com

Contact: 07957 440 724

[Specialising in Discounted Gift Trusts for Inheritance Tax planning, and investments]

[dsforrester]

What happens if the DGT bond is off-shored (e.g. Isle of Man) and hence growth is shielded from the 20% tax that a UK-based bond would face? Presumably that would mean that the beneficiary would have to treat all the gain as income (divided by the number of years the policy has been in force?)

My mother's advisor tells me that the tax is on the total gain - which I suppose is your final point. If the bond is UK based, and the gain was 77k - i.e 7700 as income, then there would be no income tax to pay providing that the beneficiary had less than 14700 income. Which makes it clear that it is very beneficial to have a low-earner as the beneficiary who can then 'PEP' the proceeds to other higher-earning family members.

DSF