What happens when you bring two complex financial planning arrangements together and who is liable for tax? In this article, Quilter spotlights investments bonds within a discretionary trust with some relatable examples.
A popular way for clients to gift money into a discretionary trust is to open an investment bond first and then place the bond in trust. Investment bonds are perfect within a discretionary trust as they simplify tax reporting for the trustees – here’s how:
- The underlying funds are owned by the bond provider, which means the trust has no direct liability for the income yields and capital gains that occur.
- Instead, a liability only arises when a chargeable event is triggered.
- This means less paperwork and simpler tax management for the trust.
Income tax is payable on the chargeable gain, but which party is liable?
Initially, it’s the settlor, if the gain arises during their lifetime or the tax year of death
Example 1:
James is the settlor of a discretionary trust created in January 2013. James dies in the 2025/26 tax year. As he is the sole life assured, his death is a chargeable event and triggers a gain. The chargeable event occurred on the date James died and, by default, falls in the tax year of death, placing the liability on James.
The legal personal representatives (LPRs) dealing with James’ estate will report the gain as part of James’ income for the tax year of death. Top slicing relief may apply depending on James’ circumstances. Any tax due can be reclaimed by James’ estate from the trust.
The trust is liable if the settlor cannot be taxed
Example 1 continued:
If James had not been the sole life assured, his death would not have brought the bond to an end. The trustees would continue to hold the bond and distribute to beneficiaries when required. Any chargeable event, such as a surrender, triggered from 2026/27 onward would be taxable on the trust.
The liability would be reported by the trustees in the trust tax return. Trusts currently pay 45% on income where total income exceeds £500 in a tax year (as of 2025/26). Top slicing relief cannot be used.
There may be split treatment where there’s more than one settlor
Example 2:
Katherine and Henry jointly settle a discretionary trust. Henry died in the 2016/17 tax year, but the bond and the trust continued. In the 2025/26 tax year, the trustees choose to surrender the bond and distribute the proceeds to the beneficiaries. Surrendering the bond triggers a chargeable event in 2025/26.
As the trust was jointly settled, the gain is divided 50/50, and the rules above are applied separately to each half.
50% on Katherine – She is alive at the time of the event. Taxed at her marginal rate, top slicing relief available, and the tax can be reclaimed from the trust.
50% on the trust – Henry died in a prior tax year, so he cannot be taxed. The liability falls on the trust, taxed at 45%, with no top slicing relief.
Whilst most joint trusts are equally settled, some settlors contribute different amounts, in which case the gain should be apportioned accordingly.
Assigning the bond may help reduce the tax charge
The trustees can assign the bond, or segments of the bond, to a new owner without triggering a chargeable event (as long as the assignment is not made in exchange for money or money’s worth). The new owner can then trigger a chargeable event after the assignment and be taxed at their marginal rate.
This can be a useful tool for discretionary trusts when distributing funds to beneficiaries, especially where the beneficiary would pay a lower rate of tax compared with the settlor or the trust.
Have another scenario not covered here?
Visit Quilter’s chargeable event hub for guides and calculators to help with your planning. www.Quilter.com/CEHUB.
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