IT IS not just the super-rich who will be hit by the higher tax rate introduced next month. SIMON Dobson looks at its effects.

FROM April there will be a 50% rate of income tax for those “high earners” being paid more than £150,000. Many people may feel that this will not affect them, as they may only dream of having such a high level of income, but this new rate of tax could catch more people than expected.

The new tax rate will apply to many trusts, including those with relatively small amounts of income. This is because the rate of tax applied to all trusts that pay tax at the ‘trust rate’ will increase to 50%, regardless of the level of income received. What this means is that it may catch people who have set funds aside for children or grandchildren, as well as those who may have left money in a trust in a will.

However, it may be possible to plan ahead in order to avoid paying tax at this rate. Many types of investment products are taxed in different ways. Trustees and beneficiaries of trusts, therefore, may seek investments that are not taxed so highly. One product that could be considered in this way is the investment bond.

Investment bonds suffer tax within the policy wrapper itself. Investors can benefit from returns in such assets as cash, property and stocks and shares, all within the wrapper of the investment bond. As the policy provider, usually a life assurance company, pays tax on the fund directly to HM Revenue & Customs (HMRC), which satisfies a basic rate tax liability, the bonds are easy to administer.

The life assurance company running the investment bond can offset the costs of running the policy against the growth within the fund. As a result, the effective rate of tax within the bond can be even less than the deemed basic rate (for UK bonds) of 20%. This will appear very attractive to anyone suffering tax at 50%. The best way to illustrate this is with a case study.

Doris dies and leaves £100,000 in a trust to provide for her children and grandchildren. Her sons, John and David, are trustees and struggle to find decent returns within the trust, especially as interest rates are so low. Her sons are further irritated because what little interest they would earn within the trust would be taxed at 50% as the trust is discretionary and falls within the new tax rules.

Finally, John and David are also worried about dealing with the trusts’ tax return and any accounts that may be needed.

John and David took independent advice and used the money in the trust to buy an investment bond. They were noted as ‘lives assured’ on the policy.

As a result of this:

The interest and income within the policy was thereafter only taxed at 20%.

No tax returns were required for the money within the bond. Administration and accounting costs were greatly reduced.

Doris’ grandchildren were invited to go on a foreign school trip. David and John appointed segments of the investment bonds to the grandchildren so that they could use the money to pay for their school trip. There was no tax to pay when the segments of the bond were appointed to Hayleigh and Kieran.

The grandchildren, Hayleigh and Kieran, were able to use their own tax rate bands when their segments of the bonds were encashed. As the gains on their bond segments did not cause them to become higher rate tax payers, there was no further income tax to pay when they surrendered their segments.

The trustees reduced their administration, reduced tax and managed to afford an educational experience for Hayleigh and Kieran.

Clearly, investment bonds will not be the best option in all cases. It is important that appropriate advice is taken.

Simon Dobson is manager in the investments and pensions team at Newcastle-based law firm Dickinson Dees.

The new tax rate will apply to many trusts, including those with relatively small income