The intricacies of the UK tax law surrounding trusts and offshore bonds can significantly impact the overall effectiveness of these financial planning tools. As of 2023/24, basic rate taxpayers are subject to a 20% tax on gains from offshore bonds. However, since gains are generally treated as forming the highest slice of income, a basic rate taxpayer could potentially be pushed into a higher tax bracket. This situation is where the ‘top slicing’ relief may assist in reducing the rate of tax charged by applying a spreading mechanism1.
New legislation from the Spring Budget 2023 is set to introduce several simplifications to the taxation of trusts and estates. These reforms include provisions that trusts and estates with income up to £500 do not pay tax on that income as it arises. Furthermore, the default basic rate and dividend ordinary rate of tax that applies to the first £1,000 slice of discretionary trust income will be removed. These changes will apply for the tax year 2024 to 2025 onwards2.
Trustees of offshore policies under discretionary trusts are liable to a basic rate tax on gains up to £1,000, where this hasn’t already been set against other non-savings income, otherwise the rate applicable to trusts applies (45%). Given this high tax rate, trustees may consider an assignment of the bond or of specific segments to beneficiaries prior to encashment, thereby reducing the tax liability4. Furthermore, a deed of appointment under bare trust may be considered for a minor beneficiary, offering more planning opportunities5.
The discounted gift schemes, often used in conjunction with trusts, have undergone significant changes. As of May 2023, the valuation rate of interest used by HMRC in valuing the retained rights under discounted gift schemes has increased from 4.5% per annum to 6.75% per annum. This valuation rate of interest is crucial for determining the open market value of the retained rights under these schemes, thereby impacting the transfer of value when a person enters into a discounted gift scheme678.
Loan trusts, Flexible reversionary trusts, and Settlor Interested trusts.
Apart from bare gift trusts and discounted gift trusts, other commonly used trusts include loan trusts, flexible reversionary trusts, and settlor interested trusts. Each of these has unique features, benefits, and tax implications, which we will explore in detail.
A Loan Trust is a method by which individuals can retain access to their capital while potentially reducing their Inheritance Tax (IHT) liability. The Settlor loans an amount to the Trust, which is then invested in an offshore bond. The Settlor can withdraw the original loan amount, usually in regular instalments, throughout their lifetime. Any growth on the investment is immediately outside of the Settlor’s estate for IHT purposes, providing potential tax savings. However, the original loan amount remains within the estate until it is fully repaid.
Flexible Reversionary Trusts, on the other hand, are designed to provide the Settlor with a regular income while also offering potential IHT benefits. The Settlor gifts an amount to the Trust, which is then invested in an offshore bond. The Settlor reserves the right to regular withdrawals, which are paid out on specified dates. Any unused withdrawals accumulate and can be paid out at a later date. Like loan trusts, any growth on the investment is outside of the Settlor’s estate for IHT purposes. However, the gift into the Trust is a Potentially Exempt Transfer (PET), meaning it will only be exempt from IHT if the Settlor survives for seven years from the date of the gift.
Settlor Interested Trusts, such as life interest trusts and interest in possession trusts, are types of trusts where the Settlor or another individual retains a right to benefit from the trust assets. With these trusts, the Settlor can still benefit from the income generated by the offshore bond, while the underlying capital can be passed to other beneficiaries, often upon the Settlor’s death. However, because the Settlor retains an interest in the trust, these trusts may be subject to IHT rules.
Trusts, and in particular bare gift trusts and discounted gift trusts, can offer compelling benefits when utilised in conjunction with offshore bonds. However, the complexities of the UK tax system and recent changes to the law necessitate careful planning and advice. As ever, it is crucial to take into account the individual circumstances of the settlor and beneficiaries, and to seek professional advice where necessary. The tools discussed herein offer powerful strategies for effective wealth management and tax planning, but they should be used judiciously and with a full understanding of the potential risks and rewards.