PET and Life insurance

Trusts Discussion
#1

If say, a 7 year term life insurance policy is put into trust with a transfer value of nil.

On death of the insured and the payment into the trust of the death benefit. Does the payout of the assured sum represent an addition or an increase in value to the trust?

If a PET of property (300k) is made shortly before the life insurance. If in absolute trust, on the death of the settlor within 7 years, would the policy NOT be a failed PET, as the premiums were made out of annual allowances/normal expenditure; the assured sum is paid to named beneficiary - free of deductions.

And, if discretionary, no CLTs due to exemptions. But potentially subject to periodic, exit charges.

#2

Typically a term assurance would be settled on a bare trust or a discretionary trust.

X takes out a term assurance on his own life. He then declares that he holds it on trust for Y who has an absolute right as against X with respect to both income and capital. This is a bare trust. On X’s death the proceeds of the policy belong beneficially to Y but are paid to X who holds the legal title; it is because of this that there should be at least two trustees, not just X, to avoid the need for probate to obtain the life policy proceeds.

Premium payments made by X are PETs but normally the annual exemption or normal expenditure out of income exemption apply.

If a discretionary trust is used possible exit and periodic charges are in point but the nil rate band may be available depending upon X’s history. As above premium payments are likely to be exempt.

Malcolm Finney

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#3

I am not sure what is meant by an “absolute trust”. If it means owned by the beneficiary absolutely and beneficially, pursuant to the making of a declaration of trust, I agree with Pav’s analysis.

If the policy is transferred to a DT, I agree that the the settlor’s cumulation will be nil and the premiums could be exempt. If the donor died within 7 years, the policy proceeds could be distributed before the first 10 year anniversary free of IHT. This is because under s68 (5) IHTA the rate is nil, as the only relevant components are the setllor’s nil cumulation prior to the commencement of the settlement and the initial settled property, the policy, which has a value of nil. The transformation of the policy into money on the death of the settlor and, if exempt, the premiums are not “additions” to the fund.

If the fund was retained until the first 10 year anniversary it would have available a full nil rate band for the charge at that date under s66 and also on interim distributions in the next 10 years under s69. As the policy pays out ÂŁ325,000, only capital appreciation would raise the effective rate above nil (assuming the nil rate band is not changed).

If the donor makes a PET of ÂŁ325,000 before he settles the policy the position is different. If he does not survive 7 years he will have a cumulation of that amount before the settlement commences which will mean the trust charges will be calculated either with no available NRB or, if taht increases, only with the increase. The cumulation of the settlor before the transfer into the settlement affects all subsequent IHT trust charges. It seems arguable that a distribution made before he dies cannot take the eventual failure of the PET into account in determining the rate on it.

If the donor makes the PET after the policy transfer into trust (but not to it) it has no effect on the rate of tax applicable to subsequent trust chargeable events. The order of gifts is thus critical.

Also vital is that the premiums should be exempt so that they are not “additions” to the trust under s67. This could be so even if not first paid into trust for the trustees to pay out but paid direct by the settlor to the insurer. An addition is one that increases the value of the trust property not just one which settles a new asset.

Where a policy has no market value it must surely be arguable that the settlor’s payment of the premiums direct to the insurer does not increase its value: it only maintains it. Payments in to allow the trustees to then discharge the premiums cannot benefit from that argument. An addition within s67 can bring in the settlor’s cumulation in the 7 years before the date of the addition, including the transfer creating the settlement (though nil here) and also any made afterwards (chargeable or failed PET) although not made into the settlement itself.

Jack Harper

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#4

So essentially, if A makes a PET equal to the value of the NRB to B. Then, shortly, takes out a 7yr term life insurance in trust - assured sum 300k.

Whether it be a bare or discretionary, if the trustees pay the proceeds to the beneficiaries promptly, say within a matter of months. As the premiums paid were under exemptions. There are zero costs involved.

Bare trust - beneficiary takes absolutely. DT - similar, therefore no periodic/exit costs.

My thinking is that if A is in their late sixties, can do a PET and take out a term policy.

If failed PET - NRB allocated to gift, and receipt of lump sum - to hedge against inflation, government policies, IHT, etc… on other estate assets, where the beneficiary shall also be the deceases named executor.

And if PET acheived after yr7. Then a new NRB allowance to utilise. It seems like a good hedge as they can comfortably make the term premiums.

So if the beneficiaries were going to receive the funds absolutely. I’m thinking in this scenario, the order of gifts would be insignificant.

#5

I do not follow why a DT would be used to take a transfer of the policy if it is to be distributed out during the settlor/life assured’s lifetime and within its 7 year term. I suppose it gives a degree of flexibility in that the beneficial ownership of the policy does not have to be vested in one or more individuals from the outset.

During the 7 years while the settlor is alive and in good health the policy will have a nil market value (but see IHTM 20231). A transfer out of a DT to a beneficiary of the policy itself will therefore attract no tax charge whether the settlor had a cumulation prior to settling the policy or not. If the policy proceeds become payable and are then distributed the settlor’s cumulation prior to making the settlement will be relevant.

If the policy to be settled on a DT is taken out to fund the tax prospectively payable either on a failed PET by the transferee or payable on the donor’s remaining estate caused by loss of the NRB allocated to the failed PET it make sense to settle the policy first and make the PET second, at least one day later. If it proves necessary to distribute the policy proceeds from the DT rather than the policy itself that order will prevent the failed PET from influencing the trust tax rate. However quickly it is proposed to transfer out the policy there must surely be a risk that the life assured will die before it can be done. Unless the settlor has already made the PET before the idea of entering into a policy occurred I can’t see why this optimum order should be hard to adopt.

I am at a bit of a loss here as to why a DT would be used if the settled policy is intended to be distributed out very soon after it is settled so I may be missing something

Jack Harper

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#6

Thanks Jack. Yes, in this instance, a bare trust makes perfect sense. The reference to DTs was just for reference should a DT ever be preferred.

Understood that if the assured sum remained in the DT upon the 10th anniversary; if PET came before CLT, upon failure, NRB would cut into the PET and significant periodic/exit charges.

Whereas, CLT before PET, NRB allocated to former. And funds in DT could be allocated for estate taxes.

#7

Hi Pav

Why not write the policy on life of another basis. You can then ignore the trust issue completely.

On the assumption there is insurable interest.

Richard
PFEP

#8

Who will own the policy?

Jack Harper

#9

Not the life assured. Whom ever effects the policy. Insurable interest can be an issue.

A insures B for ÂŁ over 7 years. B dies - A recieves the sum assured.

Richard
PFEP

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#10

Hello Richard and thank you. It can be viable option. I shall certainly look into it with interest.

Pav

#11

I suspect that a principal objective is to cover the tax consequences of A dying having made a PET within 7 years.

Jack Harper

#12

As it stands A’s main residence and 2nd home are just within ®NRBs. But, it’s more for anticipation of inflation and the reluctance of the government to increase the bands.