How buying onshore bonds can help: The inheritance tax pension rule may make six times as many people over 55 liable

Financial advisors now suggest onshore bonds to their clients in order to help them transfer wealth and avoid inheritance taxes

According to new analysis, the loved ones of up to six times as many people over 55 may be required to pay due to changes in inheritance tax rules that mean pensions will be included in calculations starting in 2027.

Following the announcement in the Autumn Budget 2024 that pensions would be subject to inheritance tax (IHT) in two years, wealth manager Quilter examined the portfolios of its thousands of clients.

A six-fold increase in inheritance tax liabilities could be imposed on the families of one in five clients over the age of 55 starting in April 2027.

In order to help clients avoid inheritance tax, advisers have begun to suggest onshore bonds and trusts.

The results are based on data from the wealth managers' platform, which includes estimated half of the clients' assumed property wealth based on average regional house prices, as well as pension assets and other holdings.

The analysis emphasizes how even formerly modest estates will surpass the frozen 500,000 IHT thresholdwhich is composed of the 325,000 main nil rate band and the 175,000 main residence nil rate bandonce pensions are taken into account.

"We are dealing with a monumental amount of change," stated Roddy Munro, head of technical sales at Quilter. The inclusion of pensions in IHT calculations will further reduce tax allowances, which have already been drastically reduced on multiple occasions, starting in 2027.

"As our clients' wealth becomes trapped in wrappers that no longer provide the same level of tax protection, our traditional approach to financial planning needs to change.

The advice on financial planning has evolved.

The tax environment for investors and savers, particularly those seeking to reduce their IHT bill, is becoming more complex due to the recent changes to the inheritance tax rules.

The effectiveness of traditional financial planning based on ISAs, General Investment Accounts, and pensions, which has influenced financial advice for the past 15 years, has been diminished by frozen and reduced allowances for capital gains tax, dividends, and the pension commencement lump sum (25 percent tax-free cash).

Financial planning must change for those who have substantial wealth in these products, many of whom are elderly people nearing or in retirement.

According to Quilter, this change is already having an impact on adviser strategies, as bonds and trusts are growing in popularity. Trusts allow clients to manage succession plans and ring-fence assets outside their estate for IHT purposes, while bonds offer tax deferral and control.

According to Quilters' internal data, since the October 2024 Budget, financial adviser recommendations for onshore bonds have almost tripled.

According to Munro, "Gifting away excess income to lower IHT liability frequently fails, particularly when investment performance tops off what has been donated." This is where bonds and trusts can be used strategically. In this new era, they can serve as the cornerstone for wealth transfer between generations if utilized properly.

He predicted that in the years to come, bonds and trusts would be much more significant in estate planning.

Avoiding inheritance tax by using trusts and onshore bonds.

By transferring an onshore bond into a discretionary trust, you are transferring the investment's value outside of your estate as a gift. Your inheritance tax bill usually won't be affected by the gift as long as you live for seven years after it is given.

Meanwhile, the bond keeps increasing in a tax-efficient shell.

Additionally, onshore bonds are taxed differently than other types of investments and are sometimes referred to as capital or non-income producing assets.

According to Shaun Moore, a chartered financial planner at Quilter, "The bond provider, the life insurance company, pays tax at a maximum rate of 20 percent on income and gains on the assets linked to the bond, as they arise, instead of the bondholder paying tax on income and gains directly.

"This implies that the bondholder typically doesn't have any more taxes to pay while the bond is increasing.

In the event of a chargeable event, the bondholder is taxable. This typically occurs when funds are taken out of the bond, like in the case of a large withdrawal or complete surrender. Even so, only if the liable party is a higher or additional rate taxpayer is additional tax due.

Trustees who are subject to trustee rate tax may find this to be especially convenient as it eliminates the need to report yearly income or gains on the associated assets to HMRC.

According to Moore, the control this structure provides is one of its main benefits.

"The trust enables you to designate trustees, who are frequently professionals or family members, who have the authority to determine how and when funds are distributed to beneficiaries, such as children or grandchildren.

Because of this, it's a good choice if you want to lower the size of your taxable estate but are uncomfortable making large outright gifts.

However, trusts have their own tax laws and obligations. There might be fees associated with establishing them, and an inheritance tax charge might be incurred right away if the amount placed in trust is greater than your available inheritance tax allowance.

Exit and ten-year charges may also apply to trusts, so it's critical to comprehend the long-term effects.

According to Moore, "These structures can be a potent component of a larger estate planning strategy when used appropriately, but they are not appropriate for everyone." To make sure it is the best option for their situation and that everything is set up correctly from the start, anyone thinking about taking this route should consult a financial advisor.