As personal circumstances change, a financial plan established for a client’s needs at one point in time may have to adapt. Therefore, it is no surprise that one of the most commonly asked questions of a life company is how the ownership of an investment bond can be altered to reflect the new reality of a client’s circumstances.
One of the strengths of an investment bond is the ability to easily alter the ownership structure through the use of assignments. In addition to this, many bonds are divided into individual segments, which, combined with the ability to assign, gives the bond added flexibility.
What is an assignment?
An assignment is a transfer of ownership of an individual’s rights or property to another person. In the context of an international investment bond, the person who assigns the bond is the assignor (original owner) and the person who receives it after the assignment is the assignee (new owner).
An international investment bond may be fully assigned, if they assign the entire bond, or partially assigned, if they assign individual segments.
What is segmentation?
Most international investment bonds are comprised of a number of individual but identical policies of assurance. These policies are commonly referred to as segments and, as they are policies in their own right, they will have their own policy number.
How does this structure help with life changes and provide options that will help a client futureproof their investment?
Some of the more common reasons for assigning individual segments are for generation planning, if joint ownership of an investment bond no longer meets the needs of the client, or the trustees need to distribute capital. Here are three scenarios for assigning bond segments.
Generation planning
Robert invested £150,000 in an investment bond comprised of 20 individual segments while living in Hong Kong five years ago. His family decided to move back to the UK just before twin daughters Sophie and Emma started university in London. Robert had earmarked the investment bond to pay for his children’s university fees and expected to need £20,000 pa for each child over a four-year period.
Now is the time he needs to take action. Robert has a successful career in the City and is an additional-rate taxpayer. Sophie and Emma have no income and so are non-taxpayers for income tax purposes.
The bond has grown in value from £150,000 to £200,000 over five years. Robert’s first option is to surrender individual segments or, second, to take a partial surrender across all 20 segments. He will then have to pay tax on the gains for each individual surrender under options one or two.
Robert’s third option is to assign segments to his children prior to them surrendering the segments.
Option 1: partial surrender
Step 1 – cumulative allowance
(5% x £150,000) x 5 years = £37,500
Step 2 – chargeable gain
£40,000 (amount required) – £37,500 (cumulative allowance) = £2,500
Option 2: full surrender of segments
Step 1 – chargeable gain per segment
£10,000 (surrender value of segment) – £7,500 (premium per segment) = £2,500
Step 2 – number of segments to be surrendered
£40,000 (amount required)/£10,000 surrender value of segment) = 4
Step 3 – total chargeable gain
4 (number of segments) x £2,500 (gain per segment) = £10,000
In either case Robert will have to pay tax at his marginal rate on the chargeable gain from the surrenders. As an additional-rate taxpayer, Robert will pay tax on the gain at 45%.
Option 3: Robert can assign segments to Sophie and Emma. Sophie and Emma are currently non-taxpayers. If Robert assigns two segments each year to both Sophie and Emma, they can both surrender the segments assigned to them.
Based on current surrender value, this will generate £20,000 each (£10,000 per segment) with a chargeable gain of £5,000 each (£2,500 per segment). The £5,000 gain will be within their personal allowance (based on current bands) and so there will be no tax to pay on the withdrawal.
Inflexibility of joint ownership
Mary and John are happily married and are joint owners of an international investment bond. They are both reviewing their wills in light of changing family circumstances.
Mary has always been financially dependent on John but has received an inheritance that leaves her secure should she survive her husband. John had a recent health scare that left him more focused on his financial legacy. His daughter from a previous marriage was recently widowed, leaving him concerned about her financial future.
John would like to leave his share of the investment bond to his daughter. However, because the investment bond is in joint ownership (joint tenants), if Mary survives John, she will automatically become the sole owner of the bond and John will be unable to use his will to leave his share of the investment bond to his daughter.
As circumstances have changed for both John and Mary, the joint ownership they have over the bond is no longer suitable for their needs. However, if they assign ownership of half of the segments within the bond to John and the other half to Mary, then they both have individual ownership of the segments assigned to them. They are no longer joint tenants in the segments and can include them in their wills
Trustee distributions
Thomas settled an investment bond in a discretionary trust a number of years ago. The intention of the trust was to provide an inheritance for his three grandchildren when they became young adults.
Thomas appointed his two younger brothers as trustees to manage the trust. Thomas passed away a number of years ago and his two brothers both reside in the UK.
The three grandchildren are now all young adults and the trustees decide it is time for them to receive their distribution from the trust. The initial intention of the trustees is to surrender the investment bond and distribute the benefits equally to each grandchild.
However, as the discretionary trust is UK-based and as Thomas (the settlor) passed away a number of years ago, the tax liability for any chargeable gain made on the bond falls on the trustees.
By fully surrendering the investment bond, the trustees will create a chargeable gain and pay income tax on the gain (over their allowance of £1,000) at the trust rate of tax, currently 45%. In addition, only two of Thomas’s grandchildren require access to the benefits immediately. The third grandchild, George, is financially secure and would prefer to leave his share of the trust fund invested.
By using the assignment flexibility of the bond, the trustees can assign individual segments to the grandchildren. The grandchildren can then determine the best time for them to surrender the segments.
It could be when they are non-taxpayers, so, instead of the gains made on the investment bond being taxed at 45% (trustee rate of tax), the grandchildren can make full use of their personal allowance and pay tax at their marginal rate.
George can also leave his segments untouched and benefit from further investment growth.
There are numerous planning opportunities that can take advantage of the flexibility of the assignment process for bonds. It is important to remember that the assignment process must be by way of a gift. If there is consideration involved, it may lead to a tax charge on transfer.
