This article makes the case for investment bonds as a way to structure transfer and protection of wealth.

Intergenerational wealth transfer is all the rage these days, and no wonder, given the ageing of the Baby Boomers. There are many ways to consider how to transfer wealth and minimise, where possible, the impact of taxes. In this article, Jeremy Pearson, technical support Manager at Canada Life, and a taxation, trust and estate planning specialist with over 40 years’ industry experience, considers the merits of investment bonds. In the interests of full disclosure, Canada Life is a provider of investment bonds. The editors of this publication are pleased to share insights with readers; they don't necessarily endorse all the views expressed and invite readers to respond.

One of the major advantages of international investment bonds is that they can provide long-term tax efficiency and adapt to changing lifetime financial needs and goals.  
Their tax position and status as a life assurance contract (or capital redemption bond) means that they could be passed down through the generations and meet a variety of needs along the way.

To illustrate this, let’s look at a case study…
Iain McAleese, a resident of Edinburgh, wanted an investment to grow in value by a significant amount, especially when compared to inflation, and that he could ‘dip into’ when he wanted. With interest rates pegged at historically low levels and the threat of growing inflation (in the UK), he had decided that he should look at potentially more rewarding investments.

His risk profile was moderately cautious, so he was looking for a portfolio that would be professionally managed to balance risk and return to that end. He was long retired and wanted an investment that could continue for his family’s benefit after he died. He wanted it to provide for his family’s changing needs through the generations, whilst being tax-efficient and administratively simple.

He consulted his professional adviser who provided a shortlist of his investment options and in due course he decided to invest £250,000 ($316,385) in an international investment bond. The investment would be managed by a discretionary fund manager and to ensure continuity it was issued as a capital redemption bond over 99 years.

In order to give as much flexibility as possible the bond was set up with 250 individual policies, each with a premium of £1,000. Iain lived for five years, taking withdrawals totalling £62,500 from the bond during his lifetime (including the ongoing adviser charge), but then he unfortunately died.

At that time, the bond was worth £300,000 and it formed part of his estate. After a grant of confirmation was obtained, the executors transferred the bond into his son Finlay’s name – who was the sole beneficiary under his will. The inheritance tax due on the estate was paid from other resources.

The overall gain on the bond was £112,500 at the time of Iain’s death, but no chargeable event occurred because all his withdrawals had been within the 5% tax-deferred allowance and on his death, there had not been "a death giving rise to benefits". This was because it was a capital redemption bond that simply stays in force until the end of the term, even though the owner may die.

University costs
Some time later, the eldest of Finlay’s children, Aoife, who is 18, starts a three year degree course at University.

Finlay would like to make sure she is not burdened with a student loan for years to come and contacts their professional adviser to discuss the best way to give Aoife enough money to pay for her tuition fees and living costs.

As Aoife will be at university, and she has no other income, she will have an unused personal allowance of £11,000. In addition, the starting rate for savings income of £5,000 and her personal savings allowance of £1,000 are also available; a total of £17,000.

This is an opportunity to realise some of the bond’s chargeable gain with no actual tax liability.

The adviser emphasises to Finlay that he must assign the policies to Aoife first and then let her cash them in. That will mean that her unused allowances will apply and she will get the proceeds tax-free. So he assigns 10 policies to her with a chargeable gain of £7,500.


This will be a transfer by Finlay for IHT purposes; after the annual exemption is used up, it will be a potentially exempt transfer. As this assignment is not for money or money’s worth, no chargeable event occurs until Aoife cashes in the policies.

In the two following years, he assigns another 20 policies in total and as before, the chargeable gain falls within her allowances. Aoife graduates without a huge debt hanging over her.

The other grandchild
Aoife’s brother, Ruari, didn’t go to university but he has been very successful landing a job in Glasgow and earned enough money for his needs. However, a few years later he gets married and starts a family a couple of years later.

He soon finds that he needs to move to a bigger house and rather than take on a bigger mortgage he speaks to his dad.

Finlay agrees that 30 policies will be transferred to Ruari, so that both he and Aoife will have benefitted from an equal number of policies. However, there is a slight issue. Ruari is a higher rate taxpayer and if he cashes them in, he will pay 40 per cent tax on the chargeable gain.

This situation can be avoided, because Ruari’s pregnant wife Katherine is off work and going to have little income in the current tax year, so Finlay assigns the polices  to her and she cashes them in.

As this assignment is not for money or money’s worth, no chargeable event occurs until Katherine cashes in the policies. As with Aoife, she has little taxable income so can make use of her allowances to offset the gain.
As before, this will be a potentially exempt transfer by Finlay for IHT purposes.

Five years later
Five years later, Aoife and Ruari are worried about their father Finlay’s situation. His business collapsed and this hit him hard both financially and health-wise. He has a modest pension, as he always said "my business is my pension", which pays him £16,000 a year. Apart from the bond, he has modest other wealth.

To deal with his spending needs, Finlay cashes in 10 policies - there are now 180 policies remaining.

The chargeable gain is £21,600 which means that Finlay’s total income is £42,600 - below the basic rate tax threshold, so there is no need to consider top-slicing relief - and only basic rate tax will apply.

After deducting his personal savings allowance, the tax bill is £4,320. The personal allowance is used by his pension and the savings rate does not apply as that is also covered by his pension income. Aoife and Ruari persuade him to set up a power of attorney (property and financial affairs) so they can deal with the bond if his health deteriorates further.

Death
When Finlay dies, the capital redemption bond stays in force – only when it is cashed in (or withdrawals exceed the 5 per cent allowance) will there be a chargeable event. Finlay’s executors transfer the bond into Aoife and Ruari’s names after the estate has been settled.

Helping the next generation
Aoife, like Ruari, now has children and they could use policies to help all their children with the cost of education, buying their first home, setting up a business or anything else they think appropriate.

Also, the investment philosophy adopted by the discretionary fund manager could be changed at any time to match the attitude of the new owner or owners.

What has been achieved?

An international investment bond offers a simple and straightforward, tax-efficient investment solution for those looking to invest a lump sum.
In this case study, Iain has received withdrawals, the bond has been used to assist his family, it helped Aoife graduate with no debt, Ruari has moved to a larger home and Finlay was helped out after his business collapsed.

All of this was achieved with no or relatively little tax applying to the gains made.

But one point is notable, the fact that the family needed the help of a professional advisor throughout, to ensure that they made the correct choices.