Periodic charge under a whole life plan

Trusts Discussion
1

When calculating the periodic charge for a discretionary trust that holds a whole life pure protection plan when looking at the available nil rate band I have always just deducted any CLTs made by the settlor in the 7 years before the trust commenced. However, I am seeing whole life plans with large premiums that are not covered by the normal expenditure out of income or annual exemption. Looking at IHT100d G3 is asking whether the settlor made chargeable transfers which increased the value of the trust. I would like people’s opinion as to whether the settlor paying premiums to maintain the plan increases the value of the settlement. Mine is no it doesn’t - the trust holds a plan which will pay out a death benefit, until that settlor dies or is in serious illness health the “deemed transfer”, at a 10 year anniversary, is the total premiums paid. It would seem to be double taxation if 7 years worth of premiums was then also taken into account to determine the trust’s available nil rate band.

Any thoughts would be welcome.

Kim Jarvis

Royal London

2

While most of us see a non-savings term life policy as providing a lump sum on death for family and dependents, HMRC’s paranoia is visible from Space. IHTM20012 says that life policies are “often used as IHT mitigation and avoidance devices”. They go on to state the truism that ordinary charging provisions will apply.

That means that in principle the payment of a premium can be a TOV and unless exempt a CLT or PET. The latter will now only be so for a policy owned by another individual or held on a disabled trust (an addition to an IPDI trust must be a separate settlement as the settlors will be different).

Where the policy is not just a wrapper for investments the effect of paying a premium will not intentionally be to increase its value but rather to maintain it on foot. It may not even actually increase the open market value of the policy which is a function of the sum assured and the life assured’s life expectancy at any given time.

S.167 directs a premiums paid basis for market value but under subs (1)(a) not on death nor under (1)(b) where the valuation event does not involve the policy leaving the transferor’s estate so not on RPT chargeable events.

I have not myself come across a non-wrapper policy that required or allowed premiums of the kind you describe so I can only speculate on how much value they might add to the policy.

There are 2 provisions dealing with additions to an RPT settlement as the payments will be. S.62B(1)(d) IHTA deals with same day additions which do not count. More apposite is s.67 and subs(1) and (2) make it clear that a chargeable transfer which merely increases the value of existing settled property is an addition for the RPT charges. Subs(2) goes on to make 2 exceptions: (a) is linked to intention and (b) to a maximum 5% increase in the value before the transfer of the property in question. So premiums which are not disregarded under these exceptions and are not exempt will be CLTs in their own right and additions for subsequent RPT IHT charges.

Jack Harper

3

Thanks Jack much appreciated.

Kim

4

How would a whole-of-life policy be certain to be funded out of “normal expenditure”” when the genuine purpose is to provide timely liquidity? especially now that pension surpluses are to be added tot he estate from March 2027?

5

A good start would be to read IHTM14231-14255. Essentially an individual should calculate his annual income and deduct his annual outgoings including tax on income to arrive at annual net disposable income. That is the amount he can give away within the exemption each year.

The gift must have an element of recurrence but a commitment by the individual to a contractual arrangement, such as to pay policy premiums, will be accepted by HMRC as qualifying from the first payment. The amount of the annual premium should be set to come within the expected future annual amount of net disposable income, calculated as described above, leaving a margin for error if fluctuations are a possibility. The £3000 annual exemption if otherwise unused can be a safety valve if there is an occasional shortfall of income.

If the policy is settled then, if and when it matures, the policy proceeds will not be part of the settlor’s IHT estate. The beneficiaries of the trust should be those who are likely to benefit under that estate so the trust fund can be distributed to them to fund the tax in question. This can often ensure that assets of the estate do not have to be sold to pay that tax. It may assist in preserving intact all or part of a pension pot after 5 April 2027 so that the underlying investments do not need to be disturbed in order to pay tax. The settlor cannot be a beneficiary of the trust but a surviving spouse can be.

Important choices are who should be the life assured, the precise terms of the trust, and when the policy proceeds will become payable. For spouses and civil partners the plan will often be to ensure the estate of the first to die is fully exempt so that the money will then be needed on the death of the survivor.

A savings policy will gradually acquire a market value over its duration but if the settlor has a nil cumulation when the settlement is created the trust will have a £325k nil rate band at any 10 year anniversary. If a spouse or civil partner makes a separate settlement that can be doubled. They must have separate income to use the exemption or keep the premiums within the £3000 annual exemption. While the only asset of the trust is a life policy it is ideally prudent to ensure that IHT will not be payable at 10 year anniversaries because the trustees NRB will cover the charge.

An alternative is to set up a bare trust for adult children, spouse or civil partners and make a lump sum payment to the trustees. This will be a PET to the children and an exempt transfer to a spouse or civil partner. The trustees will invest in a single premium life or capital redemption policy which have a special income tax regime. If a beneficiary dies their share will be part of their IHT estate if not exempt e.g. left to a spouse but the policy will usually be structured to allow money to then be released from the policy to pay out the share.

Where someone is close to retirement they may have difficulty in ensuring that their future income will remain sufficient to cover the future premiums and attract the exemption. This may require a change to investment strategy, investing more for income such as taking interest annually from one year ISAs not rolling it over or taking part of a pension pot as pension income despite income tax on it, hopefully not above basic rate.

This is just one, although a very valuable, feature of general estate planning, namely how to fund payment of the tax, which can be a bit of a cinderella aspect and should not be.

As ever taking specific tailored advice, preferably from someone who knows what they are doing, is sensible.

Jack Harper

Jack Harper

6

Jack this si very helpful I have a particular client case which I would like to have advice on It is relatively straightforward f but I think it wise to take advice before implementing. The pension will have a surplus subject to IHT, which takes the estate over £2M, so the thought is to convert most of the pension to an an annuity to give regular, increased income and to apply some of that to a whole of life for the benefit of the children and grandchildren. In days gone by, we would have used the Married Women’s Property Act Trust supplied by the live office

7

Regrettably this kind of planning is necessary where the Government of the day is minded to dramatically disturb the key tax ingredient of long-term financial planning.

An unwelcome feature is that there must be a general election in 2029 and a different incoming lot may row back on the policy. It helps greatly if the strategy has intrinsic merit come what may.

Even if the status quo was fully restored the current rules would charge income tax on whoever extracted funds from the pension pot once the pensioner was over 75. This is surely fair in the light of the tax reliefs on contribution and investment growth, while these remain undisturbed.

The prospective tax cost would depend on the aggregate exact tax burden on them all, discounted for deferred payment of the liabilities. So taking out some of the fund in current income involves a near term tax sacrifice. That may be fully justified if it is counterbalanced for IHT by an exempt series of gifts and a life policy trust. For some the action may reduce their total taxable estate below £2M ensuring that RNRB is not lost or tapered.

I am with many advisers who consider that the decision of a Government to charge the fund to IHT is legitimate, apart from its retroactivity, but that the IHT paid should be credited against the income tax payable by those who take out funds, rather like the “tax pool” of discretionary trusts functions. Indeed currently where funds are paid out from pension pots to such a trust income tax at 45% is paid up front with repayments if appropriate on distribution. All that would be needed would be to treat the new IHT charge in the same way even in the absence of a trust. The maximum combined rate of 67% is arguably extortionate whereas the additional rate of income tax or a flat rate as such a maximum would not be.

Jack Harper

8

With taper we go over 80% tax which will only hasten the exodus from the U.K. who will then need to survive for 10 years unless we can provide for the liability.

Who is going to take on the personal representative task when the pensions dashboard is still not available.

Thank you for your prompt replies we will have to see what the puzzle palace at number 11 have for us in November.

9

The unintended consequences are a cause for concern. The Treasury are keen to redirect investment into long-term infrastructure projects; however, these will usually be illiquid, so they will have to take a haircut to attract a buyer unless there is a secondary market put in place. Typically, this is -40% + . Infrastructure will be a hard sell unless the institutions do it.

If adding the pension to the IHT estate tips the client over the £2 million, then the tax charge is 84% not 67%. With the haircut, you might as well take the lot. Wealth creators are leaving the UK in response.

10

John is right that if the pension pot takes the survivor’s or unmarried individual’s estate over £2m the marginal rate of IHT on the fund will exceed 67% as the RNRB taper operates. I’ll take his word that ultimately that could reach 84%.

For a married couple or cohabitants the will of the first to die could employ the old device of a NRB DT. This will ensure that currently £325k will reduce the survivor’s own estate. There could also be an IPDI in part of the house limited to a value of £175k for the children to attract RNRB. The survivor may not mind technically being a part owner if trustees are the others.

If part of the house is appropriated to the DT not only will there be no tax on the estate, and £500k will escape the survivor’s taxable estate, but so will the future capital appreciation of those two trust funds. The survivor can then use her own NRB and RNRB if the estate is below £2m. There are no transferable NRBs but both will have been utilised maximally against their separate estates without bunching on the second death.

The DT would have a zero rate of IHT on an exit charge in the first 10 years (if the deceased had a nil cumulation) but there might be a TYA charge, in effect on the increase in value. CGT PPRR would be available under s.225.

The loss of that in the IPDI trust would be a nuisance but provided the children have nil cumulations they could make a CLT with gift insurance by surrendering their life interests which, craftily, would convert the trust into a DT with the survivor as an eligible beneficiary who will live in the property and s225 will be due apart from the IPDI short period. The deceased is the settlor so the same charges may arise as on the NRB DT.

The more children have an IPDI the better and some of them may be better IPDI candidates than others as regards the use of their NRB against their CLT. Of course a 20% lifetime charge is to be avoided.

Both of these trusts could be left to s.142 variations but particularly the IPDI trust, which at the relevant future time may not be worthwhile. The NRB DT will be within s.144 after the first death but the IPDI trust would not be. Implementing it by way of variation would facilitate an accurate valuation of the size of the interest in the house to be settled.

This seems elaborate but it is possible that it will save £175k of RNRB which would be lost if the ultimate size of the taxable estate of the survivor means there is no RNRB or TRNRB at all. It also takes £500k plus future appreciation of the house out of that taxable estate, at the cost perhaps of TYA charges and exit charges on that appreciation. Also each trust property and that interest owned personally by the survivor at the second death will benefit from at least a 10% discount for unmarketability and another 5% where the property is residential and occupied at the time of the tax charge in circumstances which would be unlikely to secure that a hypothetical willing purchaser would obtain a court order for sale.

Jack Harper

11

A correction. The NRB DT and the initial IPDI trust would be related settlements. On an exit charge in the first 10 years the former IPDI trust would suffer a charge because the notional transfer would be the value settled on NRB DT plus the value in the IPDI trust at conversion to an RPT. So £500k minus £325k= £175k. Strangely the NRB DT is not affected because the related settlement was not an RPT at commencement and its later conversion does not count so it has a full NRB. Assuming the settlor had a nil cumulation of course.

Also I think it preferable that the children’s’ IPDIs should be terminated by an exercise of the trustees’ overriding power of appointment.

Finally s.102ZA FA 1986will make each CLT a GROB if the children are eligible beneficiaries of the RPT but this will not matter if the property is appointed out to them into their taxable estate. It will be a s.102(4) PET if to their own children.

Jack Harper