A Retained Interest Trust creates a split interest which divides the investment bond into a “retained portion” and a “gifted portion”, usually on a 50%/50% basis.
- The retained portion is held on trust for the settlor and the gifted portion is held on trust for the future beneficiaries either as a discretionary trust or as an interest in possession trust with power of appointment. The Settlor can receive up to 5% per annum of the original purchase price of the bond, which is funded entirely from the retained portion. The withdrawals are set against the Settlor’s interest in the trust.
- The gifted portion is a Potentially Exempt Transfer if it is written as an absolute trust where the beneficiaries cannot be changed in the future. Conversely, the gifted portion is treated as a Chargeable Lifetime Transfer (CLT) if it is written as a discretionary trust where the beneficiaries can be changed in the future. The CLT would be based on the total investment less the immediate surrender value of the settlor’s retained portion.
- The gifted portion falls out of the Estate after seven years.
- All investment growth in the gifted portion is outside the Settlor’s Estate for Inheritance Tax purposes.
- The 5% withdrawals are based on the total original investment but are taken from the retained portion.
- The Settlor has access to the capital held in the retained portion.
- No income tax charge is liable under the Pre-Owned Assets (POAT) rules, because the Settlor’s retained portion is segregated from the property held in trust for the beneficiaries.
Withdrawals are sourced from the retained portion of the trust, which may not be sustainable if there is insufficient growth in the underlying investments. One solution may be to create two investment bonds, one written in trust, the other not and to withdraw 5% per annum in total which is likely to be more sustainable than 10% being withdrawn as income from the retained portion only, assuming the retained and gifted portions are equal from outset.