Offshore bonds and discretionary trusts Tax efficiency meets estate planning…

This doesn’t mean gains are tax-free though. Instead, gains are generally subject to income tax. As a result, much of the value of offshore bond planning comes from controlling when a gain arises and who ultimately becomes liable for the tax. This is because offshore bonds are typically divided into individual policy segments which can be assigned to another person. An outright assignment can transfer ownership of a segment to another individual, meaning that person may become responsible for any chargeable event gain. Where those segments are assigned outright to someone who pays tax at a lower rate, without that person paying for them, the eventual tax outcome may be more favourable, depending on the assignee’s tax position after the gain is added to their other income.[1]

Another notable feature is the cumulative 5% tax deferred withdrawal allowance. Investors can withdraw up to 5% of their original investment each policy year without creating an immediate tax charge, with unused allowances rolling forward. It’s worth noting that this is a tax deferral rather than a tax-free allowance. This means that the deferred gain may become taxable when a future chargeable event occurs.[2]

Typically, offshore bonds are used by high earners who have already maximised pension and ISA allowances, or whose pension contributions are restricted by the tapered annual allowance.

Advantages of offshore bonds

Offshore bonds tend to come into their own once pension and ISA allowances have been fully utilised. Alongside the cumulative 5% withdrawal amount, the greatest strength is the ability to control the timing of taxation. Rather than paying tax on gains as they arise, investors can defer the tax point to a future date. This can be particularly attractive for individuals who plan to become a lower or basic-rate taxpayer in retirement or who intend to assign bond segments to family members with lower levels of taxable income.

If reducing the value of your estate is important, gifting segments can be a useful strategy. Provided the gift is an outright gift, the donor survives seven years, and the gift is not subject to the gift with reservation rules, the value transferred can fall outside your estate for inheritance tax (IHT) purposes.[3]

They also offer a tax-efficient environment for long term growth. Investors can switch between underlying funds and investment strategies without triggering immediate CGT. This can allow portfolios to evolve without creating unnecessary friction.

Disadvantages and considerations of offshore bonds

The benefits of an offshore bond are heavily dependent on how and when it’s eventually accessed. Tax is deferred, not avoided, and gains are generally taxed as income when a chargeable event occurs. This means investors should have a clear exit strategy from the get-go. An offshore bond is often most effective where there is a realistic expectation that gains will be realised during a lower-income period or by a lower-rate taxpayer.

Costs should also be considered. Depending on the provider and investment approach, offshore bonds can carry higher charges than some alternative investment structures.

Tax rules can be complex. Factors such as chargeable event gains, top slicing relief, residency status and trust ownership can all influence the eventual outcome. As a result, a financial adviser can be beneficial in this regard. You can read more about offshore bonds in detail in our article: Offshore bond taxation: Complete guide for high earners | Saltus.

What is a discretionary trust?

A discretionary trust is a legal structure that allows assets to be held by trustees for the benefit of a group of potential beneficiaries. The person who creates the trust is known as the settlor, while the trustees are responsible for managing the assets and deciding how they are distributed. A trustee can be the settlor, or they may be family members, trusted individuals or professional trustees, depending on your circumstances.

The defining feature is trustee discretion. Rather than beneficiaries having an automatic entitlement to the assets, trustees decide who benefits, when distributions are made, and how much is received. This flexibility means decisions are based on beneficiaries’ circumstances at the time rather than made decades earlier.

Discretionary trusts can hold a wide range of assets, including cash, investments, property and (you guessed it) offshore bonds. Their primary purpose is not investment management but control and succession planning. They are particularly useful for when a settlor wants to pass on wealth while retaining confidence that it will be managed responsibly and distributed appropriately.

Advantages of discretionary trusts

Two of the greatest advantages of a discretionary trust are control and flexibility. Assets can be set aside for future generations without giving beneficiaries unrestricted access, making trusts particularly useful where beneficiaries are young, financially inexperienced, vulnerable, or where family circumstances may change over time. Trustees also can adapt their decisions as circumstances evolve. This can be helpful when navigating changing family dynamics, marriages, divorces, business ventures or differing financial needs between beneficiaries.

They can also be useful in IHT planning. While the immediate tax advantages are often overstated, a transfer into a discretionary trust is normally a chargeable lifetime transfer, and, depending on the amount transferred and the settlor’s available allowances, an entry charge may arise. Further IHT could become payable if the settlor dies within seven years.[4]

Provided the settlor does not retain a benefit and the relevant conditions are met, assets placed into trust can fall outside the settlor’s estate after seven years, and any future investment growth within the trust will generally sit outside the estate from the date the gift is made. However, the trust itself may remain subject to periodic charges, including ten-year charges, and exit charges when assets leave the trust.

Disadvantages and considerations of discretionary trusts

Trusts are subject to their own tax regime, with income and gains often taxed at higher rates than those applying to individuals. In addition, trusts can be subject to inheritance tax entry charges, periodic charges every ten years, and potential tax consequences when assets are distributed.

Administration is another consideration. Trustees have legal and fiduciary responsibilities, and trusts typically require ongoing record keeping, compliance and professional oversight. Legal, tax and trustee fees can all reduce the overall efficiency of the arrangement.

Importantly, once assets have been transferred into trust, they are generally no longer the settlor’s assets. A trust should therefore only be established where the individual is comfortable relinquishing ownership and has sufficient resources outside the structure to meet their own future needs.

As with offshore bonds, financial advice is essential to determine whether a discretionary trust is suitable. You can find out more about them in our article: What are the benefits of discretionary trusts?: And should I use one? | Saltus.

Combining an offshore bond with a discretionary trust

Before you take out an offshore bond, you should consider your exit strategy. Or, in other words, who you want to benefit from the investment and how you expect to access it. If the intention is simply for it to be another source of retirement funding, you may only need the bond itself. You can retain the segments and potentially access them when your income tax rate is lower.

If you intend to pass segments to family members the position might be different. Of course, you can assign or gift segments without necessarily using a discretionary trust, but you may want additional control over who benefits from the asset and when.

A discretionary trust may therefore be worth considering where control, protection and flexibility over future distributions are important. Remember, the offshore bond and the trust are doing different jobs: the bond provides the investment wrapper and its associated tax-planning features, while the trust provides greater control over who benefits and when.

Overall, the question is not whether an offshore bond and discretionary trust should always be combined, but whether the additional control provided by the trust is needed for your particular exit strategy.

Passing bond segments to children

Trusts can be particularly useful when children or grandchildren are involved. A discretionary trust allows trustees to decide who should benefit from the bond and when, rather than giving a beneficiary an automatic right to the asset at a certain age.

If trustees decide that a child should benefit, they can appoint a bond segment to that child using a deed of appointment. Where the child is under 18, this will often involve appointing the segment into a bare trust for them.[5] The child becomes entitled to that segment, while the trustees continue to look after it until adulthood.[6]

A discretionary trust gives the trustees flexibility. They can decide which beneficiaries should benefit and, subject to the terms of the trust, when and how much they should receive. A bare trust, by contrast, gives a particular beneficiary an absolute entitlement to the asset. Once a bond segment has been appointed into a bare trust for a child, that segment belongs beneficially to that child, even though the trustees look after it while the child is under 18.

There can also be tax implications. Gains on a segment held in a bare trust are normally assessed on the beneficiary. However, where a parent settles assets for their minor child, the parental settlement rules can apply, meaning that if the relevant income exceeds £100 in the tax year, the whole amount, not just the excess, may be taxed on the parent.[7]As a result, simply gifting a bond segment to a child does not necessarily produce a tax advantage.

The position can be different where the grandparent, rather than a parent, made or funded the settlement, as the parental settlement rules do not generally apply. In these circumstances, a grandchild’s own tax allowances may be available when a gain arises, depending on their individual circumstances.

A common planning approach is to use a discretionary trust first to retain flexibility, then appoint specific segments into a bare trust when trustees decide a child or grandchild should benefit. As is likely clear, it can be complicated, so speaking with a financial adviser is recommended.

Key considerations

Trust entry charges of up to 20% may apply where transfers exceed the available nil-rate band when paid by the trustees, subject to the applicable inheritance tax rules and rates.[8]The choice of trustees is critical, as they may be responsible for managing family wealth for many years. The needs of both current and future beneficiaries should also be considered from the outset.

Investment suitability remains equally important. An offshore bond should align with the individual’s and family’s objectives, time horizon and appetite for risk. Investors should also recognise that tax legislation can change over time, potentially affecting future outcomes.

Given the legal, tax and investment considerations involved, ongoing professional advice is essential. Ultimately, the success of any combined strategy will depend on individual circumstances, objectives and family dynamics.

Final thoughts

An offshore bond and a discretionary trust serve very different purposes. An offshore bond is primarily an investment wrapper designed to enhance tax planning flexibility, while a discretionary trust is a legal structure focused on control and succession planning. The choice isn’t necessarily one or the other.

Rather, the starting point should be your intended exit strategy. If you want to take advantage of the tax planning benefits of an offshore bond and simultaneously have greater control as to when and how your beneficiaries receive their segments, combining both may be beneficial. As is hopefully clear, it can be complicated so seeking financial advice is recommended.