Most Brits unaware onshore bonds can help beat inheritance tax – here’s how

More people than ever are looking for ways to lower their loved ones’ inheritance tax bills, according to financial advisers. Yet one simple method has been flying under the radar.

A significant number of people (47%) plan to pass down their wealth to future generations, with more than a third (38%) intending to transfer assets directly to their children, according to investment, protection and retirement company LV.

However, many families remain unaware of how to do so while paying as little inheritance tax as possible.

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At the same time, significant changes to inheritance tax (IHT) introduced in the 2024 Autumn Budget – including making defined contribution pensions liable for IHT from April 2027 and introducing new caps on business and agricultural relief – have prompted many individuals to seek out ways to avoid inheritance tax or at least reduce their IHT bill.

One solution rising in popularity is the use of onshore bonds. These are a type of bond issued by UK-based providers that offer a simple and effective way to grow savings while keeping the taxes the investor pays to a minimum.

But more than two-thirds (67%) of people know almost nothing about how bonds can be used for inheritance planning and tax mitigation, according to LV’s research.

Sarah Hills, wealth proposition director at LV, said: “With more people looking to pass on their wealth, it’s essential that they are aware of the financial planning tools at their disposal.

“Onshore bonds offer a valuable option, combining tax efficiency with investment growth potential and flexibility, which can support clients as they prepare for later life and to leave a lasting financial legacy.”

How do onshore bonds work?

Onshore bonds are a way of investing while paying less tax. This is possible because onshore bonds fall under the “chargeable event” regime. So while gains may be subject to income tax, they are not subject to capital gains tax.

A chargeable event could be cashing in your bond. But you can withdraw up to 5% of your initial investment (as capital repayments) each year without triggering a chargeable event – this is known as your tax-deferred allowance.

When a chargeable event does occur, what’s known as “top-slicing relief” is available. This allows gains to be taxed over the whole time invested, rather than treating it as taxable income in the current tax year. This can mean the whole gain could fall into a lower rate of tax.

Plus – because an onshore bond is treated as having already paid basic-rate tax at 20%, even though in reality, the bond will normally have paid less than this – investors get a 20% tax credit against their tax liability.

This means that, after top-slicing, any of the gain that falls into additional-rate tax will only trigger 25% income tax, higher-rate taxpayers will only pay 20% and basic-rate and nil-rate gains will have no income tax liability.

Inheritance tax benefits of offshore bonds

One way to use onshore bonds to avoid inheritance tax is to gift them. Onshore bonds can be assigned to family members without triggering a chargeable gain. And as long as the giver survives seven years, there is no inheritance tax to pay.

The new owner will be treated as if they have owned the bond from inception, enabling them to benefit from full top-slicing relief and any unused 5% tax-deferred allowances on any cash they take from the bond in future.

But, increasingly, families are seeking out the inheritance tax benefit from onshore bonds when they are written in trust.

When you place an onshore bond into a discretionary trust, you're making a gift that begins to move the value of that investment outside your estate. Provided you live for seven years after the gift is made, it typically won’t count towards your inheritance tax bill.

The trust allows you to appoint trustees who can decide how and when money from the onshore bond is paid out to beneficiaries such as children or grandchildren. This can be a good option if you are not comfortable giving large sums away outright but still want to reduce the size of your taxable estate.

Experts say that when integrated into a broader estate planning strategy, onshore bonds can help mitigate IHT and support a smoother, more structured intergenerational wealth transfer.

According to wealth manager Quilter, bonds and trusts are becoming more popular ways to reduce IHT bills. Bonds provide tax deferral and control, while trusts enable clients to ring-fence assets outside their estate for IHT purposes and manage succession plans.

Quilter’s internal data found recommendations for onshore bonds from financial advisers has nearly tripled since the October 2024 Budget.

LV’s Hills said: “Bonds remain a valuable option and it is clear that greater awareness and education are required to ensure clients fully understand their options and can make informed decisions.”