George and Andrew have recently been appointed trustees of a family trust set up by their late father David. On reviewing the trust papers they find the trust fund is worth about £200,000. Two-thirds of this is held in deposit accounts with different banks; the remainder is held in “blue chip” equities.
George and Andrew are keen to minimise the running costs of the trust (in particular the costs of preparing tax returns and accounts) while ensuring the fund generates an “acceptable” return. The beneficiaries are David’s grandchildren and David has provided the trustees with a letter of wishes suggesting the fund is used to support the costs of university education.
George and Andrew have asked for clarification of their responsibilities in terms of investment of the trust fund and whether a life assurance bond would be a suitable investment. What are the trustees’ duties in relation to investment?
“The duty of the trustee is not to take such care only as a prudent man would take if he had only himself to consider, the duty is rather to take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide.”
(re Whiteley) (1886) 33 ChD 347
… and on further appeal to the House of Lords
“Business men of ordinary prudence may, and frequently do, select investments which are more or less of a speculative character; but it is the duty of a trustee to confine himself to the class of investments which are permitted by the trust, and likewise to avoid all investments of that class which are attended by hazard.” 1887 12 App Cases 727
What is clear from the above is that trustees must clearly avoid risk.
What should be the trustees’ investment objectives?
The duty of the trustees in relation to investment is to use their powers in the best interests of current and future beneficiaries.
“In the case of a power of investment, as in the present case, the power must be exercised so as to yield the best return for the beneficiaries, judged in relation to the risks of the investments in question; and the prospects of yield of income and capital appreciation both have to be considered in judging the return from the investment.” (Cowan v Scargill) [1984 3WLR 501] Trustees should obtain the best rate of return regardless of their own or the beneficiaries’ political, social or moral views. In a later case the court held that investment involved “…seeking to obtain the maximum return by way of income or capital growth which is consistent with commercial prudence”.
Should trustees consider the use of a life assurance bond as an investment?
The key features of a bond, in the context of suitability as a trustee investment, are it does not produce income and the assets underpinning the bond’s value may be changed (switched without triggering a disposal for capital gains tax purposes). Bonds are also automatically diversified and diversification can be increased by use of the extensive funds links available in most situations.
Additionally, bonds can be assigned without triggering a capital gains tax disposal and in the case of an offshore bond the linked fund does not suffer any UK or domestic tax (except for small amounts of irrecoverable withholding tax). This increases the potential investment return; the “gross roll-up” effect.
How are the trustees’ investment duties met by the use of a bond?
Where trustees are obliged under the terms of the trust to produce income, a bond would not be a suitable investment as it does not generate income. Bonds do produce a level of diversification. Switching to vary the investment profile can be undertaken without a capital gains tax charge.
As bonds do not produce income, their uses as a trustee investment removes the need for a self-assessment return. Trust accounting and investment record keeping is also simplified. This significantly reduces the administrative costs of “running” the trust. The trustees are under a duty to maximise the return on the investment. The return is the return after tax and expenses and not simply the after-tax return.
The fact the bonds can be assigned without a tax charge means trustees can fulfil distributive functions tax-effectively. In effect, tax responsibility is passed to the recipient beneficiary thus again minimising administrative costs and ensuring an even-handedness of treatment.
Gerry Brown is a tax specialist at Prudential