Financial Planning and Trusts - Life Policies Flashcards
What are the uses of trusts policies in conjunction with a life policy?
Life assurance - can be placed into trust at outset or (usually) by assigning an existing policy.
Uses
• Protect family, e.g. protection policies
• School fees
• Protect partnership - to buy out a deceased’s partner’s share of a partnership from their estate or to compensate estate of a deceased partner for loss of their share of a
partnership where this is left to a surviving partner(s) in deceased’s will
• Directors’ share protection – to provide funds on death to buy out deceased director
• IHT planning – term assurance to pay tax potentially due on PET, whole life to protect estate, savings plans to place money outside of estate
Life policies and statutory trusts
Statutory Trust is a trust created by law e.g. rules of intestacy, Married Women’s Property Act 1882 (MWPA)
MWPA - can take out MWPA Policy;
• On own life
• At outset
• No existing policies
• MWPA trust allows an individual to write a policy under
trust for benefit of spouse / civil partner +/or children only
o Can be unnamed to account for future
children/remarriage
o Benefits will go to the spouse on claim/maturity
o If spouse named, court could vary terms of trust on
subsequent divorce, but this is not automatic (divorce
does not destroy named spouse’s interest)
o Children includes illegitimate and adopted but not step-
children or grandchildren.
o Can specify children must reach certain age to benefit
o Can restrict to children of existing marriage or to
legitimate children if so wish
o Should child pre decease parent, their share can go to
their own children/ siblings as per policyholder’s wishes
and terms of trust
• Usually bare / absolute trusts (therefore gift = PET)
o Not flexible
o Can set up power of appointment trust
Class of beneficiaries must only be spouse / civil
partner +/or children
But then subject to relevant property regime
• i.e. subject to entry (CLT), exit and periodic charges
- Policyholder need not be married/in a civil partnership
- No need to be resident/domiciled in England/Wales (even though Act only applies here)
- No joint policies
- No life of another policies
- Life policies only
- No need to name Act in policy for it to take effect, but best to do so for clarity
- Higher degree of protection from creditors on bankruptcy
Married Women’s Property Act 1882 (MWPA) - Trustees
• Trustees
o Appointed by policy
o Usually spouse/civil partner and policyholder
On death spouse/civil partner only need policy and death
certificate to claim proceeds
o Can vest power of appointment in themselves/others
Can include power to remove trustees
o If policy holder only trustee on their death their LPRs takeover
They will require grant of probate / letters of
administration to claim
Quicker if ensure there’s another trustee (no need to
wait for grant/letters)
• Scotland – Married Women’s Policies of Assurance (Scotland) Act 1880
o Main difference if policyholder bankrupt within 2 years of taking out policy, TIB can claim premiums paid.
o Also–delivery does not apply (see below)
• Northern Ireland – Law Reform (Husband and Wife) Act (Northern Ireland) 1964
o Differences
Joint policy with spouse/civil partner allowed
Child includes stepchild, illegitimate, adopted and
legal guardian
Private/ non-statutory trusts
• Created by declaration of trust
• Advantages over MWPA;
o Wider beneficiaries, more flexibility, decide who will
ultimately benefit
o Can put existing policy under trust
• Must ensure 3 certainties are met
o Word, subject, object Knight v Knight
• Process for new policy
o Proposer (settlor) completes declaration of trust
Life office issues policy under trust
Settlor sole trustee
o Trust gives trustee (settlor) power to appoint other
trustees
o Trustee completes deed to appoint other trustees
Legal title of policy then assigned to all trustees
o JL2D policies should usually have a 3rd trustee so that on
2nd death there is a trustee left to claim and distribute the
proceeds to the beneficiaries
o No stamp duty
• Process for existing policy
o Policy must be assigned
o Execute trust deed
Policyholder assigns policy to trustees for benefit of
beneficiaries
Deed usually states policyholder will continue to pay
premiums
o Should inform life office of assignment
Keep deed with life policy
o Assignment transfer of value for IHT
• Scotland
o Delivery needed for a trust to be valid (exceptMWPA)
Trust property must be physically delivered to
trustees/beneficiaries with intent to create trust
• Or register trust deed in Book of Council and
Session
• Or ‘Intimation’ (document confirming recipients
informed of trust)
o Can be made on behalf of minors
o Life offices usually offer choice of Scottish/English law
Scottish court can overrule choice and decide
Scottish law applies unless deed expressly states
English law applies
Claims under trust policies
• Life office can only deal with trustees (they are the legal owners)
• Trustees have right to claim on death / maturity
o If trust deed doesn’t specify then under Trustee Act
1925 s.15
have power to surrender, make paid-up, and borrow
o Have duty of care to protect property anyway
Covers making paid-up and borrowing to pay
premiums
o Proceeds must go to beneficiaries
o If convert any policy, must ensure it continues to be
under trust
• On claim need to provide
o Trust deed, policy document, deed of appointment
of(new)trustees(not MWPA), deed of retirement of
trustees,
death certificate of any trustees who are deceased
o Life office will expect all trustees to sign form of
discharge acknowledging policy has paid out
o Life office may agree to pay direct to beneficiaries at
trustees request (will require identify check for
beneficiaries and trustees to sign indemnity form) or
may only pay to trustees as legal owners
Dealings by beneficiaries
• Cannot usually claim against life office
• Can only deal with their beneficial interest under the trust
o Can assign/ mortgage this if over 18
o Person they assign/mortgage to should inform
trustees of their interest
• Can bring trust to end under Saunders v Vautier 1841 rule
Trust policies and Bankruptcy
Bankruptcy
• If life policy not under trust goes to TIB
• Under trust cannot usually go to TIB
o MWPA almost totally protected
If proved set up to deliberately defraud creditors,
TIB can only recover premiums paid from policy
proceeds
Proceeds cannot be used to pay debts
Taxation of life trust policies - when is income tax applicable?
Income tax
o Chargeable event on a non-qualifying life policy (e.g.investment bond) may give rise to a chargeable gain
Death of life assured, assignment (though not to
beneficiary), maturity, part surrender over 5%
cumulative annual allowance, full surrender
• 5% is based on original amount invested
• 5% can be taken each year and the tax is deferred until final
encashment
• If not used in one year, 5% can be carried forward (providing
no more than 100% taken overall)
o If tax due then for UK based life policies there is a 20% tax credit, offshore policies no credit
Taxation of life trust policies - income tax. Who is liable to pay tax on chargeable gain?
o Settlor pays;
If settlor alive and UK resident just before gain tax assessed on them
Same if settlor dies in tax year of gain
Settlor pays at highest rate less 20% credit (if onshore)
Top-slicing available
Can recover tax from trustees
If does not reclaim = transfer of value for IHT unless can cover it with exemption (annual / normal expenditure)
o Trustee pays;
If gain arises in tax year after UK resident settlor dies
If settlor was non UK resident before gain and trustees UK resident
Trustee tax depends on type of trust
• Discretionary - if gain falls within standard rate band no
tax to pay on onshore bond (20% credit covers it) 20%
on offshore. Over standard rate band additional 25%
onshore bond, 45% offshore.
• Bare trust, beneficiary assessed to tax unless parental
settlement rules apply
o Beneficiary pays
Trustees not UK resident, settlor not UK resident just
before gain or died in previous tax year UK
beneficiary pays at own rates
o Dead settlor rule(trick)
Only applies to policies taken out and put into trust
pre 17 March 1998 and settlor died before then
Liability falls on settlor but because settlor is dead
there is no liability as long as policy not altered to
extend term / increase benefit since that date
o Assign policy to beneficiary
Rather than cash in policy and giving rise to a
chargeable gain, can assign policy to beneficiary
• Beneficiary could then control when to cash in and
pay tax at their own rates
Taxation of life trust policies - when is CGT applicable?
o Only arises where policy assigned for money/money’s worth
Unlikely to happen with trust policy
IHT and life policies
When settlor takes out a life policy under trust - this is treated as a a transfer of value.
o Regular premium life policy
Premiums are transfers of value
May be exempt under annual exemption (£3,000 a year)
or normal expenditure from income
• Under latter criteria must be regular, paid from net
income and not affect settlor’s standard of living
o Single premium
Premium transfer of value
Bare / absolute / vulnerable beneficiary trust = PET
• Additional premiums, if made, also PETs
Other trusts = CLT
• IHT lifetime rate @ 20% of value exceeding NRB
• Die in 7 years charged at death rate (40%) less amount
paid during lifetime
o Taper applies after year 3
• Periodic and exit charges may apply o Assignments
Transfer of value
• Greater of
o Premiums paid less surrender value paid out (if
any)
o Market value (surrender value)
• Term assurance market value usually negligible
o Unless life assured in ill-health
• Unit-linked policy
o Can have a reduction if fund value has fallen
since outset
o Not for bid-offer spread
o Death of life assured
Generally no charge to IHT a trust policy outside
deceased’s estate
• Exception if transfer into trust was a CLT and
further tax is now due
What is Pre-owned asset tax (POAT)?
• Anti-avoidance measure to prevent setting up IHT schemes to avoid Gift With Reservation (GWR) rules
• Does not usually apply to life policy trusts
o May apply to business trusts
• POAT is an income tax charge (not an IHT charge)
• On gifts made since 18 March 1986 (despite only being introduced in 2005!)
• Converts benefit someone gets from having free or low-cost enjoyment of an asset they formerly owned (or provided the money to buy) into a cash equivalent value which is added to their other income for the year and liable to income tax
- For land, the cash equivalent is the market rent
- For chattels and intangibles, it is the official income tax interest rate (currently 2.5%) of the capital value of the asseto For intangible assets, POAT only applies if asset held in a settlement (i.e.not a bare trust) and if the donor/their spouse can benefit from the income
- Land or chattels must be re-valued every five years
- No tax is payable if the cash equivalent is less than £5,000 in a tax year
- If full market rent/value is paid for use of the asset there is no POAT
- If a contribution towards the full market rent/value is paid, this amount is deducted from the cash equivalent value (and therefore reduces the income tax charge payable)
• If do not wish to pay tax can
o Bring benefit to an end (eg. cease to enjoy)
o Dismantle arrangement giving rise to benefit
o Pay market rent
o Opt out and elect for benefit to be treated as GWR (election irrevocable, done by 31 Jan after end of tax year liability to tax charge arose)
Reasons to elect as GWR
• Asset may qualify for BR/AR at 100 / 50%, spouse exemption may apply, asset fall within NRB, owner young/healthy
Reasons not to elect as GWR
• Can afford charge, short life expectancy, charge under £5,000 (and therefore not payable), prefers to keep IHT burden to their estate rather than beneficiary
Life policies and business trusts - uses?
Basically so cash funds are immediately available on the death (or critical illness) of a business owner, for surviving business owners to purchase deceased’s interest.
• Take own life policy in trust
• Sum assured value of share in company/partnership
• Use discretionary trust
o Beneficiaries other share holders/partners
o Settlor included so they can get the proceeds paid to them if
leave
o Partners/children of shareholders/ partners should not be
beneficiaries
• Cross-option agreement
o Surviving shareholders/ partners have option to buy
deceased’s share
o Deceased’s personal representatives have option to
sell
o If either party exercises their option, the other must
comply - Providing they do so within permitted time
frame
o Share qualifies for BR if owned for 2 years - but not if
binding or contract sale used
- Life policy premiums paid into trust are CLTs unless fall under annual / normal expenditure out of income exemptions
- Periodic/exit charges unlikely on term policy unless life assured in ill-health
- Not deemed as GWR if all set up on purely commercial basis (ideally all partners should have reciprocal policies, if not HMRC may deem GWR for partner who has a policy and access to it)
- Proceeds won’t form part of deceased’s estate
- POAT charge could arise but due to market value (surrender value) of term policy being low unless life assured in ill-health it is unlikely
Income tax and CGT for non-UK resident trustees / settlors
• Trust non-UK resident if all trustees outside UK
• If 1 trustee in UK, trust is UK resident if settlor was UK res / dom when trust was set up or had funds added to it
• If 1 trustee in UK, but settlor not UK res / dom when trust set up or had funds added to it, then trust non-UK resident
• If trust becomes non-UK resident
o Assets treated as disposed of and bought back straight away at
market value
o Gains charged to CGT at settlor’s rate if they have an immediate
or potential future right to income / capital in the trust
• UK res & dom settlor can be taxed on gains in non-UK resident trust
o If they have an interest in the trust in tax year gain arises
o Can reclaim tax from trustees
• If settlor not charged CGT, UK dom and UK res beneficiaries will be if they receive capital payments
o Tax maybe increased if gains not distributed in tax
year they arise or the year after
• If beneficiary dispose of interest in non-resident trust, gain is chargeable
Relevant Life policies - uses?
• Employer funded life policy
• Written on life of employee
• Favourable tax conditions if
o Sum assured pays out lump sum on death before 75
o No surrender value
o Any ill-health benefit only pays out while still
employed
o Beneficiaries individual/charity either direct/via
trustees
o Main purpose of policy not tax avoidance
• If conditions met premiums not taxable benefit for employee (no income tax due), no NI for employee or employer
• Discretionary trust should be set up at same time as life policy
o Death payment goes to trustees
o Trustees decide which beneficiaries to pay it to
Usual to include spouse/civil partner, children,
grandchildren
Employee can make non-binding nomination
Employee also beneficiary in case need to make
terminal illness benefit payment
If employee stops working and employer carries on
paying premiums, should remove employee as
beneficiary otherwise = GWR
• If new employer starts to pay then can remain
o No IHT on creating discretionary trust, no periodic/exit charges unless in ill- health
o Payment of benefits no implications for IHT (outside estate)
o Trustees do not have to pay out benefits in one go
Could invest for beneficiaries and pay out income
stream
But, once death benefits paid, belong to trustees
If exceed NRB periodic/exit charges may apply
