8 - Life Assurance & Pensions in trust

Question 1

Life Assurance Trusts

3 situations which call for life assurance written under trust

Answer 1

• Family protection;
• Partnership/shareholder protection;
• IHT planning

Question 2

Life Assurance Trusts

What are the benefits to writing a life assurance policy under trust?

Answer 2

• To ensure the correct beneficiaries receive the proceeds;
• To remove the proceeds from life assured’s estate and avoid IHT;
• To speed up the payment of proceeds as trustees don’t have to wait for probate to make a claim;
• To retain control over who the proceeds are paid to via choice of trustees;
• To protect the value of the policy from creditors.

Question 3

Life Assurance Trusts

How can life assurance trusts be created by statutory means?

Answer 3

Under the MWPA 1882, if a husband writes life assurance for the benefit of his spouse, or spouse and children (illegitimate or adopted are ok, but NOT step-children or grandchildren) it is put in a statutory trust for their benefit.

MWPA trusts are inflexible, but offer protection from creditors and take the assets outside the hudbands estate (so no IHT and if he owes money to anybody they can’t take the proceeds).

Question 4

MWPA

What policies can be written under the MWPA?

Other restrictions

Answer 4

• Single Life only;
• New policies only;
• Own life only.

They’re also inflexibile, mainly in that the beneficiaries are restricted.

Question 5

Life Assurance Trusts

How are claims dealt with?

Answer 5

The life office will deal with the trustees, since they are the legal owners of the life assurance contract.

Question 6

Life Assurance Trusts

What do the trustees need to do if the life assured dies?

Answer 6

• Make a claim to the life office;
• Provide proof of title (eg trust deed, death certificate, policy documents);
• Distribute/manage the benefits for beneficiarites in accordance with the provisions of the trust.

Question 7

Life Assurance Trusts

How can life assurance generate income tax?

Answer 7

Life assurance policies don’t generate income per se, but can create chargeable gains.

This isn’t the same as CGT (which can occur if policies are assigned), but when policy payout occurs and is greater than the premia paid.

Question 8

Life Assurance Trusts

How are gains on life assurance policies in trusts taxed?

Answer 8

• If the person who created the trust is alive (immediately before the chargeable event, or in the same tax year) and UK resident before the chargeable event it is treated as part of their income with top-slicing available;
• If they’re dead (chargeable event after the tax year in which they died) or non-resident, and one or more trustees are UK resident, then trustees taxed at income tax rates (45% less the 20% credit is 25%, £1k SRB effectively at 0% if available);
• Otherwise any UK beneficiary receiving a benefit from the gain will pay tax without top slicing.

Question 9

Life Assurance

2 ways of avoiding tax on gains on life assurance policy in trust

Answer 9

• If the beneficiary is a nil or basic rate tax payer then replacing the trustees with foreign trustees prior to the chargeable event means the beneficiaries will be liable. No top-slicing, but rates will be lower;
• Or the policy can be assigned to the beneficiary before the chargeable event. Assignment itself is not a chargeable event.

Question 10

Life Assurance Trusts

Issues around children being beneficiaries

Answer 10

If either or both of the parents are settlors of a bare trust then they are potentially liable themselves on income tax on gains from a life assurance policy.

Question 11

Life Assurance Trusts

Is there any CGT due?

Answer 11

CGT will only be due if the contract is assigned (sold), which rarely happens.

Question 12

Life Assurance Trusts

What IHT is due?

Answer 12

The premiums are a transfer of value, so potentially IHT is due on each payment.

Typically they will fall inside the £3k annual exemption.

Otherwise IHT depends on type of trust:

• Absolute trusts and pre 22/3/06 IIPs: PET
• Discretionary trusts and post 22/3/06 IIPs: CLT

Question 13

Life Assurance Trusts

How is value determined for the assignation of a life policy into trust?

Answer 13

For IHT purpses assigning the policy is a transfer of value (i.e. selling or gifting the policy into a trust).

Typically the value is the greater of premiums paid less any sums previously paid out and the market value (surrendur value).

Term assurance policies without surrendur values are considered of negligible value.

Question 14

Life Assurance Trusts

What are “related policies”?

Answer 14

A related policy is when you write a life policy in trust and buy an annuity to pay the premiums. That way you’ve paid upfront now for a guaranteed payout to the beneficiaries on your death, but avoid any IHT charges since the life assurance premiums are covered by annual allowance.

HMRC disallows this unless you can prove the policies aren’t related (main point is to use different life offices).

Otherwise the transfer of value is considered to be the lower of:

• Annuity purchase price + first years premium; and
• The sum assured.

Question 15

Pre-Owned Asset Tax

What is the POAT?

Relevant dates

Answer 15

It is an income tax on deemed income from certain gifts made after 18/3/86.

It is only charged when the donor makes a gift and retains interest in the gift.

Question 16

Pre-Owned Asset Tax

What are the relevant categories of asset?

What is the amount of the charge?

Answer 16

Land, chattels, intangible assets.

Charge the official rate of interest (2.5% in 17/18) on the value of the asset.

If this notional income is below £5k nothing is charged, otherwise the full amount is taxed as income.

Question 17

Pre-Owned Asset Tax

What is the POAT for?

Answer 17

POAT rules are aimed at schemes which have been designed to avoid the Gift With Reservation (GWR) rules.

This is where assets are gifted while the donor still uses them, to try to get around IHT rules.

Note that if an arrangement gets hit by GWR rules, it will not also be hit with POAT.

Question 18

Pre-Owned Asset Tax

Effect on life assurance trusts (3 examples)

Answer 18

If the settlor is also a potential beneficiary of the life assurance trust POAT may apply. There are 3 specific examples:

• Business trust - designed to pay out to the other partners/shareholders if one dies, but usually term assurance so value is likely to be below £5k;
• IIP or discretionary trusts set up pre 18/3/86 - if settlor is beneficiary of the life policy they will be subject to POAT (though they were given a waiver from GWR);
• Spousal interest trusts - specifically set up to avoid GWR, where interest is given to a spouse, get caught by POAT.

Question 19

Pre-Owned Asset Tax

What options are there for avoiding POAT?

Answer 19

• End the arrangement (creates a gift for IHT purposes);
• Pay a market rent for use of the assets;
• Opt for gift to be treated as GWR instead of POAT.

Question 20

Pre-Owned Asset Tax

Considerations about electing for GWR instead of POAT

Answer 20

Electing for GWR will create an IHT gift. You might make this choice if you’ve got NRB available, or spousal exemption, if business/agricultural relief is available etc.

On the other hand you may prefer the POAT if the value is below £5k or you’re happy paying the charge (maybe short life expectancy so won’t pay for long).

Question 21

Business Trusts

What is it?

Answer 21

A business trust is designed to protect partners/shareholders should one of them die.

A life policy is written in trust on the life of one partner for the benefit of all of them.

It is combined with a cross (or double) option agreement so each side has the option to sell/buy the deceased’s share of the business.

Proceeds from the life assurance policy provide the remaining partners/shareholders with the funds to pay this cost.

Question 22

Business Trusts

Relevance of GWR/POAT

Answer 22

The settlor is usually included as a beneficiary of the policy, to protect against people leaving the business.

Since it is a purely commercial arrangement HMRC says this isn’t affected by GWR rules, however it might be hit by POAT. In reality term policies have low value and will fall below the £5k rule, unless the person has a short life expectancy.

Question 23

Business Trusts

IHT considerations

Answer 23

Unless covered by exemptions the premiums paid on the policy are CLTs.

If the settlor owned their shares for at least 2 years there should be 100% business relief available (when the value is received into the estate and passed on to descendants).

If there was a binding contract for sale there would be no business relief, however a double option agreement is not considered a contract for sale.

Question 24

Life Assurance Trusts

How is residency of a trust determined?

Answer 24

For IIP trusts the beneficiary is relevant.

For discretionary trusts the trustees determine the residency of the trust.

• If all trustees are UK resident the trust is UK resident;
• If all trustees are non-UK resident the trust is non-UK resident;
• Otherwise the trust is UK resident if the settlor was UK resident when they created the trust or any time they transferred assets into it.

[Trust being UK resident effectively mean the trustees as a group/entity are UK resident, regardless of their own residency as individuals/entities]

Question 25

_Life Assurance Trusts_ CGT issues for non-UK resident trusts

Answer 25

There are special rules around CGT to prevent avoiding tax using non-resident trustees. When the trust becomes offshore the assets are treated as being disposed of and acquired at their market value, with gains taxed at the settlors rate if they have an interest. If a UK resident & domiciled settlor retains an interest in the trust, they will be liable to CGT on gains in an offshore trust (tax paid by the trustees can be recovered). Any gains that aren't taxed in this way would eventually be charged on any UK resident & domiciled beneficiaries when they receive capital from the trust.

Question 26

_Relevant Life Policies_ What is a relevant life plan?

Answer 26

This is term assurance which must be paid before age 75 given as an employee benefit. It can't have a surrender value and ill health benefit can only pay out while employed. It is set up with a discretionary trust, member makes a non-binding nomination of benefit (must be to a charity or individual). There is no benefit-in-kind on the employee and the premiums are not subject to IHT (would normally be CLTs).

Question 27

_Pensions_ Legal status of DB and money purchase schemes Trustees

Answer 27

DB schemes are set up as trusts. MP schemes can be set up under master trust or deed poll. Occupational scheme trusts will have at least 3 trustees usually, and pensions law says 1/3rd must be nominated by members. MP scheme trust usually has the provider as the trustee.

Question 28

_Pensions_ IHT impact of pension trusts

Answer 28

Death benefits are usually IHT free because the trustees have discretion over who to pay them to. The nomination form from the member is usually followed, but it is not binding.

Question 29

_Pensions_ What is personal pension life cover? Relevant dates

Answer 29

Before 6/12/06 tax relief was available on life cover written alongside personal pensions, so it was usually offered. Existing policies continue, the premiums are usually exempt from IHT under the regular expenditure/annual allowance exemptions. The sum assured is outside the estate.

Question 30

_Pensions_ What is a retirement annuity contract?

Answer 30

Also known as s226 policies, this was the predecessor to personal pensions. Death benefits will be paid to the estate, unless you put it inside a trust.

Question 31

_Pensions_ How and why would you put a personal pension or retirement annuity contract into a trust?

Answer 31

Death benefits would be paid into the estate and become liable for IHT. To avoid this you can put the pension into a trust and retain the pension benefits, so only the death benefits are actually gifted and get passed to the surviving beneficiaries. The gift for IHT purposes would be the difference between the value of the plan and the value of the interest retained. If you survive for 2 years HMRC consider this to be negligible, but they may investigate if you die sooner and you might have known you were ill.

Question 32

_Pensions_ What is a spousal bypass trust?

Answer 32

When a pension trust pays death benefits they go into the estate, which causes problems for IHT (surviving spouse gets charge IHT when they later die and pass the value on). Instead you set up a discretionary trust for the death benefits to be paid into, with your spouse and other descendants as beneficiaries. As such if the spouse doesn't draw benefits they never enter their estate and don't get charged IHT when passed on to future descendants.

Question 33

_Gift With Reservation_ What is the impact if the settlor uses an asset that was gifted to a trust? What can be done to prevent this?

Answer 33

To avoid GWR assets have to be enjoyed to the exclusion or _virtually_ the exclusion of the settlor. In reality the value of benefit retained must be very small indeed. Effectively the gift is ignored, the asset will be included in the settlors estate when they die. Also any CGT holdover relief that was claimed will be lost. Even if GWR rules are avoided, POAT is likely to be invoked. This can be prevented by paying a commercial rent for the asset to the trust. The trust would be taxed on this income as usual.