What are Trusts
The value of any protection plan proceeds not written in trust must be added to the life assured’s estate and may be subject to Inheritance Tax (IHT).
Trusts are used for IHT planning purposes. IHT is payable at a rate of 40% on estates valued in excess of the nil rate band. It is possible for spouses to combine their IHT thresholds on the second death provided the first nil rate band was not fully used. From 6th April 2012, where 10% or more of the net chargeable estate is left to charity; IHT will be payable at the rate of 36% as opposed to 40%.
Since March 2006 most trusts are now subject to the Relevant Property Regime (RPR) the following summary highlights the three potential IHT charges that may be applied.
Discretionary Trusts / Flexible Interest in Possession Trusts
A discretionary trust allows clients to select a list of discretionary beneficiaries when establishing a trust this are often used for trust funds. Beneficiaries can change over the lifetime of the trust. The discretionary beneficiaries have no immediate interest in the trust. They receive proceeds of the trust at the discretion of the Trustees. The life assured provides a letter of wishes which covers the terms of the trust and who they wish the potential beneficiaries to be.
When a discretionary trust is created, there is usually an immediate charge to IHT of 20% on chargeable lifetime transfers that exceed the available threshold.
In addition to this, a periodic charge up to 6% will apply at every 10 year anniversary. This is applied to the value of the Trust’s assets above the nil rate band at that time.
Finally an exit charge is applied when capital is distributed to the beneficiaries between the 10 year anniversaries.
Details of the impact of these charges are set out below:
In general, where a trust is created by a regular premium life policy, there should be no 20% lifetime tax charge since the value of the gift made is simply the premiums paid on the policy. Such premiums are usually exempt from IHT either because they fall within the annual exemption (currently £3,000 per annum) or because the premiums qualify as normal expenditure out of income based on your spendable income.
Even where large premiums are paid and none of the exemptions apply, provided you have not used your nil rate band, no tax charge should arise provided that the premiums over a seven year period do not exceed the available nil rate band.
Where an existing term assurance policy is placed into trust, there is no value placed on the gift (the policy) unless the life assured was in serious ill health at the time of placing the policy in trust (in practise usually dies within 2 years of the transfer to trust). At which point HMRC will treat the value of the policy as the sum assured.
Ongoing periodic & exit charges
Periodic and exit charges apply where there is a value within the trust. Consequently as long as the life assured is in good health, or the policy has no significant surrender value, there will be no value in the trust, therefore no charges will arise. Provided the individual is not seriously ill to the best of their knowledge and belief, no further action would be needed. HMRC has indicated that for the purposes of the 10 yearly charge, generally they will accept the surrender value of the policy.
If however the surrender value is significant or the life assured is in poor health, the value of the trust at the 10th anniversary (and each subsequent 10th anniversary) may be subject to IHT at 6% on the excess above the nil rate band at that time.
More commonly charges may arise if a claim is made on the policy and the proceeds remain in the trust over a 10 yearly anniversary. Therefore if a sum assured greater than the nil rate band (NRB) was paid out and rather than being distributed immediately was held by the trustees over the 10 year anniversary, the trust would be subject to the periodic charges, as the value of the trust fund at the 10 year anniversary exceeded the NRB.
An exit charge should not arise where proceeds are paid out within the first ten years if the value of the initial gift (including the cumulative total of the any chargeable transfers in the seven years prior to the gift) plus any added property is below the nil rate band. If funds continue to be held in trust beyond the tenth anniversary any exit charges will depend on the rate of the previous periodic charge.
The following trusts do not fall into the Relevant Property regime
Under an absolute trust any beneficiaries are established at outset and cannot be amended in the future even if circumstances change.
No IHT charges arise where the policy has been placed in an absolute trust since the value of the plan will form part of the named beneficiary’s estate and not that of the life assured.
An irrevocable trust which has been established for charitable purposes
Trusts for the Disabled
An interest in possession trust where the disabled person is treated as being beneficially entitled
Interest in Possession Trust
Established prior to 22nd March 2006, where the interest in possession has not been amended.