Who’s liable for the income tax liability on an investment bond within a discretionary trust or bare trust?

For adviser use only.

Discretionary trust

There’ll only be an income tax liability arising if there’s a chargeable event gain – for example on a withdrawal exceeding the available 5% tax deferred allowance,  a segment cash in, full cash in of the bond or death of the last life assured.   Where an investment bond is held in a discretionary trust, there are special rules governing the taxation.  The income tax charge on a chargeable event gain will be assessed to tax in the following order (S464-468 ITTOIA 2005).

Settlor

  • If they’re alive and UK resident, at their marginal income tax rate.  Top slicing relief may be available depending on the settlor’s other taxable income.
Trustees
  • If they’re UK resident and the chargeable event gain arises after the tax year of the settlor’s death or the settlor isn’t UK resident.
  • The income tax rate is currently  45% though only 25% tax will be payable for onshore policies because of the availability of the notional 20% tax credit.

Trustees also have a standard rate band, which applies to the first £1,000 of taxable income.  If the settlor sets up more than one trust, then the £1,000 would be split between the trusts subject to a minimum of £200 per trust.

Beneficiaries

  • If they’re UK resident to the extent they’ve benefitted at their marginal income tax rate. Top slicing relief won’t be available.

Subject to any restrictions in the policy conditions, the trustees should bear in mind that it may be more tax efficient to assign segments of the bond by way of gift to adult beneficiaries for them to cash in.  The chargeable event gain will then be taxed at the beneficiary’s marginal income tax rate and top slicing relief may be available depending on the beneficiary’s other income.

Bare trust

If the investment bond is held in a bare trust, the tax liability would generally fall on the beneficiary(ies). Top slicing relief may be available depending on the beneficiary’s other income.

Where the bare trust has been created by a parent for their minor child, any chargeable event gains will be assessed to tax on the parent,  if the gains plus all other income from settlements by that parent for the same child exceed £100 in any tax year.