Most clients are familiar with the concept of Junior ISAs (JISA) and most media outlets covered that the JISA allowance more than doubled (£4,368 to £9,000) from 6 April 2020.
However, most clients are not familiar with the strategy of using an offshore bond in a discretionary trust when investing for children, which can achieve the same tax outcome with careful planning.
Although the JISA allowance increase is welcome it won’t change the approach to the advice. The table below lists five key areas an adviser will consider when comparing both strategies.
Offshore bond in Discretionary Trust
Low initial premiums available, often £500 lump sum or £25 for monthly.
Maximum of £9,000 per individual each tax year*
Minimum initial premium generally £20,000 but top-up premiums are significantly lower. Generally single premium option.
Contributions can be unlimited depending on fund choice.
Cash Junior ISA and stocks & shares Junior ISA available.
Account per individual only. Only parents or a guardian with parental responsibility can open a Junior ISA for under 16s.
One of each account type can be opened and funds can be transferred from one account type to another but it’s not possible to hold more than one of each account type.
New subscriptions must be made to the original account or to change provider all previous subscriptions would need to be transferred to the new provider.
Normally set up as a group of identical policies (commonly referred to as segments or clusters).
Small amount of life cover if set up on a life assured basis.
Can be available on capital redemption basis which has a fixed term (no life assured) and will pay a guaranteed amount at maturity.
The Trustees can consider multiple investment bond providers although this will depend on the size of the trust fund to meet minimum investment amounts.
Wide investment options available with stocks & share Junior ISAs.
Wide investment options available.
Withdrawals not permitted before child attains 18 except in limited circumstances e.g. child diagnosed with terminal illness
Child can manage the account from age 16 but cannot withdraw until age 18. Child has full access at 18
If child dies the funds are payable to the child’s personal representative.
If the child dies intestate** the funds would be shared equally between the parents (England, Wales & Northern Ireland). In Scotland the estate is split in two, half goes to the parents and half to the brothers or sisters.
Trustees have discretion on who benefits from the trust fund and when from a class of beneficiaries detailed in the trust provisions, usually the settlor's remoter issue as the standard class with the option to add and remove beneficiaries.
The trust fund can be distributed or used for the benefit of a beneficiary at any age at the trustee's discretion.
The trustees can assign individual segments of the bond to a beneficiary at age 18 or into a bare trust prior to age 18 to ensure chargeable gains on surrender are assessed against the beneficiary.
The trustees can withdraw up to 5% of the investment premium each policy year, without incurring an immediate tax charge.
Tax free investment return.
In beneficiaries estate.
Virtually tax-free investment growth but chargeable event gains potentially subject to income tax.
While held in the discretionary trust the funds are not in beneficiaries estate.
*based on 2020/21 tax year JISA allowance
** the intestacy guidance is based on parents and siblings being alive
John, a Draftsman, planned to retire at 60 next month. That was until his employer secured a submarine build contract that excites him so he’s agreed to work another five years. Continuing to work won’t negatively impact his pension planning but it will generate annual net excess income of £30,000 which could create an IHT issue.
He read about the new JISA allowance in a Sunday newspaper and thought a stocks & shares JISA for each of his three grandchildren, all aged under six, would be ideal for making use of his excess income for five years. However, he contacts his adviser for advice before making a decision.
The adviser explains that gifting the excess income may be covered by the normal expenditure out of income exemption (IHTA84/S21). This means the gift will be outside his estate immediately (no seven-year clock) and would not impact the IHT planning already carried out as his previous gifts were modest Potentially Exempt Transfers, not Chargeable Lifetime Transfers.
The adviser asks John if he’d heard about offshore bonds in a discretionary trust when investing for children. John had not but agrees to consider it so the adviser takes him through the five key areas from the table above to ascertain which option will be more closely aligned to John’s objectives.
John would not be able to fully utilise the £30,000 with the JISA and the parents would need to open the JISA account first to allow him to pay into it. The adviser highlights he’s not currently making use of the £3,000 annual exemption so he could still make an exempt gift to the grandchildren of £1,000 each but it’s likely to be a child’s savings account rather than an investment product. Pension contributions were discussed but John discounted due to minimum pension age.
An offshore bond for each child is unlikely due to minimum investment premium required but it would be possible to invest £30,000 (and make use of all the excess income) in a single bond for the benefit of all three beneficiaries which leads us nicely to the next key area.
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John likes the idea of a JISA account per child but didn’t like that you can’t have multiple JISAs with different providers.
As bonds are segmented John understood it would be possible to set it up one bond with a number of segments which could be divided equally between all three beneficiaries.
John could invest with a different provider for each gift of £30,000 and still use the same trust (or a new trust). John likes that he could invest with more than one offshore bond provider..
John knew investment gains would be tax-free with the JISA but he was not familiar with taxation of an offshore bond in a discretionary trust.
The adviser explains offshore bonds grow in a virtually tax-free environment (withholding tax, which cannot be reclaimed, can apply). When money is taken out or certain events happen (such as death or maturity) then a chargeable event occurs. Chargeable event gains are subject to income tax but withdrawals within the 5% tax deferred allowance do not trigger a chargeable event.
When held in a discretionary trust any chargeable event gains could be assessed against John at his marginal rate, against the trustees at the trustee rate of taxation (45%) or against the beneficiaries at their marginal rate depending on the circumstances.
The adviser explains the plan would be for gains to be assessed against the grandchildren while they are non-taxpayers by assigning segments to them directly or via bare trust if they are under 18. As offshore bond gains are treated as savings income the idea is to make use of the available personal allowance, starting rate for savings and personal savings allowance.
The adviser suggests an example to illustrate how this could work. Future tax rates and allowances are unknown, so they agree to use the 2020/21 tax rates and allowances which is £12,500 personal allowance, £5,000 starting rate for savings and £1,000 personal savings allowance.
The bond has 90 segments and around 13 years later when John’s eldest grandson Ben goes to university the bond is valued at £258,000 (roughly net 5% return). The total chargeable event gain is £108,000 (£258,000 - £150,000. The gain per segment is £1,200 (£108,000/90).
The trustees assign 15 segments to Ben who has zero income. If Ben surrendered all 15 segments the gain would be £18,000 and taxed as follows:
£12,500 (personal allowance)
£5,000 (starting rate for savings)
£500 (personal savings allowance)
In this example, Ben would still have £500 of personal savings allowance available. Based on the 2020/21 allowances an individual could realise an offshore bond gain of £18,500 without incurring any tax assuming they no other income.
John wants the money invested and it was agreed the JISA and offshore bond option would provide access to a wide range of investment funds that would be in line with his investment objectives.
The adviser highlights that contributions alone over five years would equate to £45,000 for each grandchild when considering the maximum JISA allowance over five years.
For the JISA John did not like that he would not have the option to withdraw funds before age 18 or that he would have no control once the grandchild reached 18.
He said he would also worry about the grandchildren having access to this amount of money at 18 and didn’t want it wasted on a vast quantity of pot noodles and Jagermeister!
If one of his grandchildren died before reaching age 18, he would like their share to go the other grandchildren so the intestacy position (his family live in England) is not aligned to his objectives.
When discussing the discretionary trust John liked that the trustees had control over when the funds were used, whether it be before the grandchildren reach age 18 or distributing when they are older. John would be a trustee.
John liked that there would be a wide class of potential beneficiaries so the trust fund could be used for future grandchildren but also his children if they ever required money. He liked how individual segments could be surrendered or assigned to beneficiaries and the ability to take withdrawals within the 5% tax deferred allowance without triggering an immediate liability to tax.
Offshore bonds in Discretionary Trust
After analysis of the five key areas the adviser recommends an offshore bond in a discretionary trust. However, there is no one size fits all solution. John wanted control over when the funds were distributed and product diversification options, which the discretionary trust and offshore bond structure provide respectively. The outcome of the analysis will differ from one client to the next depending on their needs and objectives.