Testamentary Trusts can provide significant asset & beneficiary protection, tax advantages and flexibility but not every family wants the ongoing administration of a trust to build wealth for children or grandchildren. Investment bonds, and their education-focused variant, offer a simpler alternative that may be more appropriate when the ongoing costs and admin of a Testamentary Trust isn’t justified.
How they work
An investment bond is issued by a life insurance company and operates much like a managed portfolio, except tax is paid internally within the structure at a maximum rate of 30%. You can instruct your executor in your will to purchase the bond on behalf of a particular beneficiary. Alternatively, you can set up the bond before you pass away if you want and keep control during your lifetime. This would also allow you to make additional contributions over time and nominate beneficiaries or successor owners.
The 10-year rule and tax treatment
Hold the bond for at least ten years and comply with the contribution rules, and withdrawals are generally treated as tax-paid, since tax has already been paid inside the structure along the way. The catch is the 125% contribution rule: where you have made any additional contributions into the bond, each year’s contribution generally cannot exceed 125% of the previous year’s, or the 10-year clock effectively restarts. A $10,000 contribution in year one caps year two at $12,500, so contribution planning needs to be tracked carefully and deliberately.
Where they beat a trust, and where they don’t
Investment bonds avoid annual trust distribution resolutions, trust tax returns and ongoing trustee administration, and on death they can pay proceeds directly to a nominated beneficiary, bypassing the estate and probate entirely. What they don’t offer is the income-splitting flexibility of a discretionary Testamentary Trust where a trustee can decide from year to year which beneficiaries are to receive the trust income.
Which to choose
The right answer depends on the amount involved, how much control you want to retain, and how much administrative complexity the family is comfortable with. For some families, an investment bond and a Testamentary Trust working side by side rather than as competing options may provide the best results.
Frequently Asked Questions
They are generally treated as tax-paid rather than tax-free, since tax has already been paid within the bond at up to 30% along the way, provided the contribution rules have been followed for the full 10-year period.
Annual contributions cannot exceed 125% of the previous year’s contribution without restarting the 10-year qualifying period. Track it carefully if you plan to contribute varying amounts over time.
Compare the numbers for your family
Whether an investment bond, a testamentary trust, or both makes sense depends on your specific contribution pattern and goals. DFK Everalls can run the comparison against your circumstances before you commit to a structure.
