Tom Archer, tax and trust specialist at Quilter, explains why the choice of lives assured on an investment bond can have significant tax consequences, affecting when a chargeable event occurs and how much planning flexibility is retained.
Investment bonds remain popular because they are taxed under an event-based tax regime known as Chargeable Events. This can simplify tax reporting and help to defer tax on growth until a ‘chargeable’ event occurs.
When an event occurs, any gain is assessed for income tax not capital gains tax. Investment bonds are usually written as life assurance policies and therefore have one or more lives assured named at outset.
The choice of life assured can have wider planning consequences. It can affect when the bond ends, when a chargeable event arises and how much future planning flexibility remains. Here are some of the key points to consider:
Death of the life assured brings the bond to an end. Where there are multiple lives assured, the bond usually ends on a last death basis. This creates a fixed end point.
A life assured has no rights under the bond. They do not become a beneficiary, are not taxable on gains and do not restrict who the bond can be assigned to. Their role is simply to bring the bond to an end when the last dies.
The end of the bond triggers a chargeable event. On death, all tax-deferred growth and income becomes taxable. The person liable for the gain is fixed, and the bond cannot be assigned. Top slicing relief may still apply, but the forced chargeable event removes the ability to plan the most tax-efficient exit.
Changing lives assured also triggers a chargeable event. Most bond providers will not offer the option to change lives assured on an investment bond. As HMRC treats a change to the lives assured as a fundamental reconstruction of the policy.
It is the same as if they had surrendered the bond and taken out a new one. It therefore simpler for all parties if this (surrendering and start again) is the route taken.
The bond should last long enough to serve its purpose. For example, a bond held by trustees of a trust may need to remain in place for many years while beneficiaries reach a suitable age, trustees decide when to make appointments, or distributions are managed over time.
In that situation, writing the bond on too few lives assured, or on older lives such as the settlors, increases the risk that the bond ends before the trust planning has run its course.
That can force a chargeable event, fix who is taxable on the gain and remove the trustees’ ability to choose the timing of an assignment, surrender or distribution.
Multiple, younger lives assured, such as intended beneficiaries, can help keep the bond available for as long as the trust needs it. In other cases, it may be appropriate for the bond to end on the death of the owner.
For example, where a client owns a bond personally and wants the proceeds to pass to their estate beneficiaries, but does not want to leave them with the bond itself.
The choice of lives assured may restrict future trust planning. Where a trust allows the settlor to carve-out rights, such as a discounted gift trust or flexible reversionary trust, it is generally recommended not to include the settlor or the settlor’s spouse or civil partner as lives assured.
Primarily this is a prudent approach to ensure gift with reservation arguments are not applied. The end of the bond may also end the settlor’s rights linked to it. For example, the settlor’s right to withdrawals from a discounted gift trust.
There may be restrictions on who can be a life assured. Insurable interest rules restrict who someone can insure. This usually means their own life, their spouse or civil partner, or someone whose death would create a personal liability for them.
These rules date back to 1774 and did not reflect investment-based life assurance. Providers generally offer broader options, provided the life assured is relevant to the bondholder. Children, grandchildren or intended beneficiaries are usually acceptable. Check the provider’s rules before setting up the bond.
In summary
Lives assured have a limited role under an investment bond, but their selection can have a significant impact. They do not have rights under the bond, but they determine when the bond ends, when a chargeable event may arise and when any death benefit is paid.
They cannot usually be changed, and where a change is possible, it is likely to trigger a chargeable event. Planners should consider the purpose of the bond and whether there is a clear benefit to it ending on the death of the owner, settlor or another relevant person.
If not, multiple younger lives assured are often preferred, as they can help keep the bond in place for as long as it is needed. For more info on what to expect following death of a bond holder or live assured, please read our guide found here.
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