Inheritance tax: Graham Southorn explains how trusts can help
Single premium investment bonds used to be a regular part of tax planning, but in recent years they’ve slipped off the radar. Now financial advisers are discovering they can bring vital tax benefits, and clients are waking up to the opportunity.
Families are stepping up their efforts to save tax, as HMRC takes a greater proportion of our money than at any time in 70 years.
The Treasury looks set to pocket more than £7billion in inheritance tax this year and that will only climb as payment thresholds are frozen all the way to 2028.
In fact, the £325,000 nil-rate threshold hasn’t increased since 2009, while the value of assets such as shares and property have soared in that time
Hunt also slashed the capital gains tax allowance from £12,300 to £6,000 from April, and will cut it again to just £3,000 from April next year. Bills are set to double as a result.
At the same time, he slashed the dividend tax allowance from £2,000 to £1,000, and will cut that in half again next April to just £500.
Single premium investment bonds can reduce the damage, yet many who could benefit know little about them.
Investment bonds are usually classed as a single premium life insurance policy because they include a tiny amount of life cover, but they’re primarily an investment product, said Shaun Moore, tax and financial planning expert at Quilter.
They are typically sold through an independent financial adviser or direct by a life insurance company.
Savers pay a single upfront premium, the minimum is typically £5,000 or £10,000, but in practice most people invest a lot more than that.
There may be early redemption charges for those who want their money back in the first few years, but these expire after a while.
Single premium life insurance policies invest your money in a series of funds and should deliver both regular dividend income and capital gains.
Savers don’t have to report their returns to HMRC every year, which saves a lot of bother.
Instead, they pay tax following a “chargeable event”, say, when they cash in some or all of the bond, or when the last policyholder dies. “All transactions are consolidated and reported in a single statement, making them simple to administer,” Moore said.
The bonds do not have a fixed maturity date, so savers can choose when to sell at the most tax-efficient time.
One perk is that you can take five percent of your original premium each year as income for up to 20 years, without paying any tax, Moore said. “Any unused part of the five percent limit can be carried forward to future years. This is effectively a return of your capital over 20 years.”
When your cash in the bond or trigger another chargeable event your gains from the underlying investment funds are treated as income for that financial year and taxed at your marginal rate.
The insurer issuing the bond pays corporation tax on its investment returns and to reflect this, HMRC will not charge basic rate tax on your income or capital gains.
Higher rate 40 percent taxpayers may face a 20 percent bill, though, while additional rate taxpayers may pay 25 percent but Moore said they may be able to avoid that legally. “If they expect their income to fall at some point, say, in retirement, they can defer any tax liability until then to avoid paying tax at higher rates.”
Insurance bonds can also be put inside a trust for inheritance tax planning purposes, as they can be gifted with no immediate liability to income tax or capital gains tax.
“For legacy planning and tax planning purposes you can have multiple lives assured on the policy, which allows a great deal of control over when the insurance bond finally ends and when tax is payable,” Moore said.
In other words, you may never have to cash them in.
Insurance bonds fall into two categories, onshore and offshore. The main difference is their tax treatment. Onshore bonds are subject to UK corporation tax but with offshore bonds the returns roll up free of tax, Moore said.
However, this means there is no basic rate 20 percent income tax credit. “Savers have to pay income tax at either 20, 40 or 45 percent, depending on their tax bracket. Plus there may be a foreign withholding tax, too.”
Single premium insurance bonds offer a tax planning opportunity that many people do not even know about, but may require financial advice to make the most of it.
It’s worth considering for those looking to thwart Hunt and protect their family’s wealth, but as ever, make sure your adviser’s fees and the bond charges don’t outweigh the tax savings.
Also consider other tax-efficient alternatives such as pensions and Isas.
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