Death and taxes…….on investments bonds

by | Oct 16, 2023

Anthony Whittaker, Client Director (Trusts and Estates) talks about the intricacies of taxation on investment bonds following a death. 

We commonly receive queries from firms dealing with probate matters who have been sent chargeable event certificates following a death and as one rule does not fit all circumstances, they can cause a fair amount of head scratching.

Because the tax on the bonds is deferred and no tax is payable during the life of the bond unless certain events occur, they are often thought of as tax free, but this is definitely not the case.

As a basic rule the owner of the bond at the time of a chargeable event will usually be subject to an income tax charge on any profits the bond has made.

The majority of investment bonds are written on a life assurance basis, which means a small amount of life cover will be paid on the death of the life or lives assured, in addition to the investment value.

On the death of a policyholder who is also the last life assured, the bond automatically comes to an end and is encashed. Any gains on the bond will be taxed at that point and the tax is reported on the final tax return of the deceased, as a lifetime matter.

Following death, the bond provider sends the chargeable event certificate to the Personal Representative (PR), and this is when we are normally asked to advise.

The chargeable event certificate provides certain information necessary to calculate the tax liability such as the amount of the chargeable gain, whether the bond is onshore or offshore and the number of years the policy has been held.

Gains made under investment bonds are classed as savings income which can cause confusion as this is one of the very few situations where a gain is charged to income tax.

The gain is added to the deceased’s other income in the tax year of death to assess whether additional tax is due. It is not possible to assess the tax impact based just on the chargeable event certificate without knowing the other income.

By having to report the gain generated in the bond in a single tax year, it can easily lead to a larger proportion of tax being paid at higher rates than would have been paid if gains had been assessed on an annual basis.

However, all is not lost as there is a relief called Top Slicing, which can alleviate this. The relief applies when the full gain takes an individual into the higher rate or additional rate bracket, but it allows chargeable gains to be spread over the number of years the bond has been in force rather than just in the tax year in which the gain occurs.

Often, we are contacted by a PR in a bit of a panic as there is a huge gain to report and they are worried about how to pay the tax. Once we have reviewed the position and calculated the Top Slicing Relief, the tax impact is often much less than first feared.

Investment bonds can be held in the UK or offshore. An important distinction is that UK bonds carry a 20% tax credit on chargeable events and offshore bonds do not.

This can be very important for PRs if a tax liability does arise on a chargeable gain, as the liability may be an allowable deduction on the estate value and can result in an IHT saving.

With an onshore bond the PRs can normally only claim any higher or additional rate tax that arises as a deduction (due to the tax credit), but offshore policies can claim a deduction for any income tax that arises on the chargeable event.

In the case of Capital Redemption Bonds, there is a major a difference – there are no lives assured.  As a result there is no chargeable event on death and if the bond owner dies, the bond continues.

On death, ownership passes to any surviving joint owner or the deceased’s PRs. If the PRs take ownership, they can choose to either encash the bond by surrender resulting in a chargeable event or assign ownership to a beneficiary of the estate.

Definitely worth noting is that during the period of administration, PRs do not get any personal or savings allowance and also cannot claim Top Slicing Relief. Therefore, it is almost always more tax efficient to consider assignment out to beneficiaries if this is practical rather than encashing in the hands of the PR.

Further complications arise when bonds are also held in trust. This topic would need further explanation, but suffice to say, a more careful review is required.

Due to the tax impact and the potential for IHT savings and the tax planning opportunities that these investment bonds present our recommendation is that the position is reviewed as early as possible in the course of administration of any estate for maximum efficiency.

If you have any questions or queries relating to investment bonds, please feel free to get in touch with Anthony and his team.

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