Learning Material Sample
Trusts8. Life assurance, investments and pensions in trustsChapter learning outcome: To understand how life assurance policies and certain pension benefits can be placed in trust and the tax and other implications
There are many reasons for placing asse...
Shortened demo course. See details at foot of page. ... in bankruptcy in certain circumstances Having a life policy in trust means that the death benefits not only fall outside the settlor’s estate, they are paid to the intended beneficiaries quickly without the need for probate or letters of administration.
The trustees will di... Shortened demo course. See details at foot of page. ...squo;s Property Act 1882 (England and Wales).Married Women’s Property Act 1882 (MWPA) This Act allows an individual to set up a trust using a life policy in situations where, aside from the Act, no trust would otherwise be created. MWPA life policies must be established on an own life, single life basis and the policy must be written under trust from outset. Policies taken out on a joint life or ‘life of anoth...
Shortened demo course. See details at foot of page. ...ed in the policy but for clarity it is preferable. The words of the policy do not need to expressly declare a trust as long as they are sufficient to bring the arrangement within the Act. Where beneficiaries are not named, but are described by relationship, the wording of an MWPA policy will need to be examined to ascertain exactly who the beneficiary is.
Where the beneficiary is specifically named, policy proceeds vest to that named individual immediately the policy is taken out. If the named beneficiary predeceases the policyholder, their interest passes to their estate on death. So, the death of an absolute beneficiary does not destroy their inte... Shortened demo course. See details at foot of page. ... (including half-siblings/adopted siblings), depending upon the wishes of the policyholder. The wording of the arrangement will help determine what these wishes are.It is possible for a power of appointment trust to be established under the MWPA, provided the class of potential beneficiaries is restricted to spouse/civil partner and children. Such an arrangement will provide for flexibility, but it is rare to find such trusts being written on this statutory basis. Trustees of MWPA policies are usually appointed by the policy itself with no further action being necessary to given them legal title. The policyholder can also appoint trustees by a memorandum under hand.
Where a policy is set up for the benefit of a spouse, the policyholder can appoint the spouse or civil partner and himself/herself as joint trustees. Whilst the settlor can retain some control during their lifetime, on death the spouse a... Shortened demo course. See details at foot of page. ...policy proceeds are generally protected from creditorsDisadvantages of MWPA trusts include: They are for single life policies only (other than in Northern Ireland) The beneficiaries are restricted They are not as flexible as non-statutory trusts Most people who use or are recommended to use trusts need flexibility and, for this reason, MWPA trusts are not widely used and have been replaced by a variety of non-statutory trusts. Policies can be written under trusts outside the terms of the MWPA. These are known as non-statutory or private trust policies.
Non-statutory trusts would be required if beneficiaries are outside the scope of the MWPA. Non-statutory trusts would also be ne... Shortened demo course. See details at foot of page. ...).Where the policy being written under trust is a joint life second death policy, it is recommended that at least one trustee who is not a life assured should be appointed to ensure that there is someone available as trustee in the event of a death claim. A policyholder can place an existing policy into trust but not into a MWPA trust.
This takes place by exe... Shortened demo course. See details at foot of page. ...hen a declaration of trust under a new or existing life or pension policy is made, no stamp duty is payable. Where any claim is made on a trust policy, the life office will deal with the trustees as they are the legal owners of the policy. Trustees have a right to claim the policy proceeds on death or maturity. As far as any other dealings are concerned, the trustees should ensure that the trust wording provides them with the necessary powers to do whatever they wish or need to do.
Many trust wordings provide the trustees with wide powers but if these powers a... Shortened demo course. See details at foot of page. ...Third parties acquiring a beneficial interest through assignment under a trust policy should inform the trustees.If all beneficiaries under a trust are 18 or over and of sound mind, they can decide to put an end to the trust and surrender or otherwise deal with the policy under the rule arising from the case of Saunders v Vautier . They might also have some rights to appoint new trustees under the Trusts of Land and Appointment of Trustees Act 1996. Where a person owning a life policy becomes bankrupt, he or she will lose control of that policy because it passes to the trustee in bankruptcy and is used for the benefit of creditors.
A policy in trust, however, is not the property of the bankrupt i... Shortened demo course. See details at foot of page. ...efore the bankruptcy, it cannot be attacked unless the bankrupt was insolvent at the time of the trust or became so as a result. The bankrupt will be assumed to be insolvent at the time if the trust was set up to benefit a relative or business associate. Income tax
Life policies do not generally create ‘income’ so the rules explained in the previous chapter do not apply. However, one area that could affect the proceeds from life policies in trust is that of ‘chargeable event gains’, as these are just as likely to occur with trust policies as they are with arrangements not written under trust. Where a chargeable gain occurs on a non-qualifying policy such as an investment bond, it is subject to income tax, not capital gains tax. The occasions when a chargeable event occurs are: Death of the last life assured Full surrender or maturity of the policy Part surrenders up to 5% of the original (plus any subsequent additional) investment per policy year do not trigger a chargeable event because such withdrawals are deemed return of capital, not as a gain or income. This means that there is no liability to income tax at the time of the withdrawal, rather, tax is deferred until a chargeable event occurs. So if an initial investment of £200,000 was made, up to £10,000 can be withdrawn each policy year without triggering a chargeable gain. If the 5% is fully or partly unused in a particular policy year can be carried forward for use in a future year. If 5% is taken per year for 20 years, all capital will have been returned, and any further withdrawals are then considered to be chargeable events and chargeable gains. The 5%s are cumulative but if at any time the cumulative 5%s are exceeded, a chargeable event occurs. Assignment of a policy to a beneficiary is not a chargeable event. Income tax is chargeable if a chargeable event produces a chargeable gain, although the taxpayer will receive a 20% tax credit for policies issued in the UK to represent the tax deemed to have been paid on the underlying funds. There is no tax credit for policies issued offshore. It depends on when a chargeable event occurs as to who is liable for the tax on that gain: If the settlor was both alive and UK resident immediately before the chargeable event, any gain is treated as part of that person’s income. He or she can recover any tax paid from the trustees. If the settlor does not pay the tax due, the amount of the tax will be deemed to be a ‘gift’ (which may still escape IHT under one of the IHT gift exemptions, but may not depending on the size of the tax liability) If the settlor was dead or resident outside the UK immediately before the chargeable event and at least one of the trustees is resident in the UK, the trustees are chargeable to any gain The charge is at the rates applicable to trusts. If the trust is a discretionary or accumulation ... Shortened demo course. See details at foot of page. ...y is the trust’s only asset, there are no IHT implications for the trust during the member’s lifetime because it has no value. However, as it is a discretionary trust, it falls under the relevant property regime and is subject to periodic (10 yearly) and exit charges. Furthermore, the trust will be treated as being created by the member, and therefore any chargeable lifetime transfers (CLTs) or Potentially Exempt Transfers (PETs) made in the 7 years before the creation of the trust will affect the periodic charge on this trust.Tax on assignments under trust The assignment of an existing policy into a trust is regarded as a transfer of value by the settlor for IHT purposes. Where the policy has a surrender value, its value for IHT purposes is deemed to be the total premiums paid (gross of any tax relief) with a deduction for any sums previously paid out by way of part surrender. The market value of the policy will apply if it is higher than the premiums paid figure. The market value is generally taken to be the surrender value of the policy. The value of a unit-linked policy is always based on its market value, not the premiums. The market value of a unit-linked policy is the number of units held multiplied by the price of the units. If the unit price has fallen since the policy was taken out, the value will be based on the new lower unit price, but no allowance is given for reduction in value due to the bid/offer spread. Policies that do not have a surrender value have negligible value for IHT purposes unless the life assured has a short life expectancy. Death of the life assured When the life assured under a trust policy dies, there is generally no charge to inheritance tax as the policy proceeds do not form part of the deceased’s estate. Death or change of beneficiary If a beneficiary dies with an interest in possession under a trust set up before 22 March 2006 (one that continues to benefit from the transitional relief), the value of the interest forms part of his or her estate for tax purposes. The policy will be valued based on its market value and the tax is based on the deceased beneficiary’s tax rates. However, the tax is paid by the trustees from the trust fund. For interest in possession trusts set up on or after 22 March 2006 (and older trusts that have lost their transitional relief), the relevant property regime applies and, consequently, IHT is payable by the trustees on the 10-year anniversary of the trust and when distributions are paid to beneficiaries. If there is a change in the beneficial interest in possession for some other reason, this is usually ignored for IHT purposes. Income tax
The residence status of trustees is relevant in determining the income tax treatment of discretionary trusts (it is the residency of the beneficiary that is relevant for interest in possession trusts) Where at least one trustee of a trust is UK resident, the trust will be a UK trust f... Shortened demo course. See details at foot of page. ... payments from the trust, based on their share of the gains. Where the gains are not distributed to the beneficiaries in the tax year in which the gains were made, the tax can increase. Also, where such beneficiaries dispose of their interest in a non-resident trust, any gains they make are taxable Some of the main reasons for placing a life policy in trust are:
Family protection – usually term assurance policies on trust for spouse/civil partners an... Shortened demo course. See details at foot of page. ...savings arrangements are set up in trust to enable money to fall outside the estate and lump sum plans are used to reduce the potential IHT bill in several ways There are several advantages to writing a life policy or pension arrangement in trust. These include:
Policy benefits can be assured of being paid to selected beneficiari... Shortened demo course. See details at foot of page. ... is often the case that settlors will specify their intended beneficiaries via a ‘letter of wishes’, although these intentions are not binding on the trustees Trusts are used in most pension schemes. The trustees have control over pension funds for the benefit of its members.
Defined benefit occupational pension schemes This type of scheme pays a pension that is expressed as a proportion of the member’s final salary at or close to their retirement. Unless the scheme is ‘non-contributory’ the member contributes a percentage of their salary into the pension fund, to which the employer also adds a minimum level of contribution. Trustees hold the pension assets for the benefits of its members, and they must follow the pension scheme’s rules which set out how assets are to be managed and how benefits are to be paid. Most schemes pay a lump sum if the member dies whilst employed by the scheme’s sponsoring employer, with benefits paid under the terms of the pension trust. This is called a death in service benefit. The trustees are obliged to pay the death benefit, but because it is in a discretionary trust and the trustees, rather than the member, have the power to determine who receives the benefits, not the member, the death... Shortened demo course. See details at foot of page. ... beneficiary falls into their own estate. Where the beneficiary is a spouse or civil partner, this can cause certain problems with their own much increased estate (potentially leading to IHT on their death).One way of avoiding this problem is for pension death benefits to be paid to a discretionary trust, where the widow or widower is included as a potential beneficiary. The trustees can use the fund to benefit the surviving spouse as well as other family members as and when required, without giving significant capital to an individual beneficiary. Such trusts are often referred to as “spousal by-pass trusts”, as the surviving spouse is “bypassed” in terms of the receiving substantial capital. This strategy prevents excess capital falling into the spouse’s estate and, as a result, can help to reduce IHT. This type of trust is not so attractive to those who have flexible access to their pension benefits, and have not been used as much since it became possible to transfer any portion of the nil-rate band remaining unused on first death of a spouse or civil partner. |
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