Managing Your Trusts Investments: Stop before you cash in
Katriona McEwan · Posted on: February 24th 2025 · read
Most trustees have a wide range of investment powers, allowing them to invest in any type of investment, so long as they align with the goals of the trust.
Types of investment may include investment bonds or a non-qualifying life insurance policy. If and when these investments are cashed in, a Chargeable Event Gain (CEG) can arise, and the profits (or 'gains') may be taxable.
A CEG refers to the increase in value of the investment bond between the time it is purchased and the time it is sold/cashed in. Despite being a gain and capital in nature, the CEG is liable to income tax.
If you are the trustee of a trust holding an investment bond or non-qualifying life insurance policy, and you are considering cashing this in, the following points should first be understood:
Tax liability depends on your circumstances
As mentioned above, the CEG, despite being a gain, is liable to income tax. However, when the policy is held on trust the person liable for the tax differs depending on the following circumstances:
- If the investment is held on Bare Trust, the beneficiary will be liable to tax on the gain.
- If the investment is held on other trusts (i.e. discretionary or interest in possession trust) the person liable to tax on the CEG is the settlor of the trust. The settlor has a right to recover any tax payable in this situation from the trustees.
- Where the settlor has died or is non-UK resident at the time, the trustees will be liable to the tax on the CEG.
UK and non-UK based investments differ in tax rates
If the trustees are liable to tax on the CEG they will pay tax at the rate applicable to trusts on savings income, currently 45%. If the investment is UK based this will come with a 20% notional tax credit so only 25% tax will be payable by the trustees. Non-UK investments do not have a notional tax credit, and the full 45% tax liability will be payable by the trustees.
If the investment is UK based this will come with a 20% notional tax credit so only 25% tax will be payable by the trustees.
Top-Slicing Relief is not available to trustees
If the profit or gain from cashing in an investment pushes a basic rate taxpayer into higher rate, or a higher rate taxpayer into the additional rate, there is a special relief available known as ‘top slicing relief’ (TSR).
This relief can help to spread the profit or gain over the life of the investment and mitigate higher rate taxes in some cases. However, this relief is not available to trustees when realising a CEG.
Income distribution vs capital distribution
While any tax actually paid by the trustees will form part of the trust’s tax pool and be available to frank future income distributions to beneficiaries, a problem arises if the trust does not have any income available to distribute.
Despite the CEG being deemed income for tax purposes it is, as a matter of fact and trust law, capital in nature. Therefore, the distribution of the investment bond funds to the beneficiaries is a capital distribution, not an income distribution. As a result, there will be no income tax credit attached to the distribution which the beneficiary could have potentially recovered depending on their personal circumstances.
"we understand trustees cannot let tax control all decisions and, in some cases, it may be appropriate for them to encash the investment even if this is not the most tax efficient option."
Assess your tax efficiency
Where the trustees would be liable to tax on the CEG, it could be more tax efficient for the bond/policy to be appointed absolutely to the beneficiary prior to any encashment, but this will always depend on the specific circumstances of each case.
This is because it allows the beneficiary to:
- Encash the bond in segments and at times that are most tax efficient for their personal circumstances.
- Make use of Top Slicing Relief which can negate any higher rate tax payable on the CEG.
- Potentially make use of the beneficiary’s personal allowance, personal savings allowance and lower income tax rates which the trustees do not have.
If the settlor would be liable to tax on the CEG and not the trustees, we would suggest comparing the settlor’s and beneficiary’s personal tax positions to assess if it is more tax efficient for the trust or beneficiary to encash the bond/policy before taking any action.
Take professional tax advice
There are of course many factors to consider when managing a trust’s investments but given the potential loss of tax when trustees encash investment bonds and non-qualifying life insurance policies, it is always beneficial to take tax advice before undertaking such an exercise.
At MHA, we understand trustees cannot let tax control all decisions and, in some cases, it may be appropriate for them to encash the investment even if this is not the most tax efficient option.
However, if appointment to the beneficiary prior to encashment is appropriate and more tax efficient it is better to know this in advance, as there is no way to go back once the encashment has occurred.
Find out more
To discuss any of the issues raised in this article, please contact the author Katriona McEwan from our Trusts & Estates team, who will be happy to assist.
For questions on other personal tax matters, please contact your usual MHA adviser or your local office.
The above is not intended to be construed as financial advice. Should you wish to obtain financial advice in respect of any investments you hold, please contact our wealth management team.
