Can I use a 'Split Trust' to reserve critical illness benefits for myself?
If you have a death or earlier critical illness policy, and assuming you wish to place the benefits in trust, it is possible to use a type of trust known as a 'split' or 'carve-out' trust.
(There is no difference between a 'split trust' and 'carve-out trust', they are simply marketing phrases both used for an identical form of trust.)
A death or earlier critical illness policy pays out in the event of death or critical illness. By using a split trust, the insured person can place the death benefit in trust, but reserve the critical illness benefit for themselves, so if the insured person suffers a critical illness, he or she can keep the policy payout.
With the possible exception of a split trust being used by a single parent, in our opinion this form of trust could give rise to an Inheritance Tax liability and should be avoided. |
Here’s an example scenario:
Let’s assume that 'Joe Bloggs' (apologies to any real Joe Bloggs) is a father who wants to take out a policy which will pay out a £100,000 lump sum in the event of his death or earlier critical illness.
He asks an adviser to set-up the cover for him. He tells the adviser that he would like to reserve the £100,000 for himself if he has a critical illness.
He also says he wants the money, in the event of his death, to go to his children; and he tells the adviser he doesn't want his children to have any liability to Inheritance Tax on the payout.
The adviser says this can be done by means of something called a 'split trust', and the policy and 'split trust' are subsequently set up.
Some years later, Joe unfortunately has a massive heart attack, but it doesn't immediately kill him.
A heart attack is one of the critical illnesses covered in his policy, so he qualifies to receive the full payout from his policy, and under the terms of the 'split trust' he is entitled to be paid the £100,000.
However, he chooses not to put a claim in to his insurance company, and doesn't inform them, because his doctor has told him that the heart attack did so much damage that he will not live long.
Some weeks later, he does in fact, die.
A death claim is now submitted to the life insurance company for the £100,000 sum assured, which is payable, as the policy covered against death as well as earlier critical illness.
His children, being aware that it is in some form of 'trust' now confidently expect to receive the insurance policy proceeds in full, without any liability to Inheritance Tax.
They did not know exactly what type of trust; their father had simply told them that they would get the death benefit proceeds without any liability to Inheritance Tax, as he had placed it in a 'trust' for them.
However, being a thorough lot, HM Revenue & Customs discover that their father had qualified to be paid, due to the heart attack he suffered before his death, the full £100,000 while he was still alive, and by not taking the money, their father had deprived his estate of this amount of money.
By not claiming, and thereby depriving his estate of the £100,000 to which it was entitled, their father had thought that the money would not be included in his estate on his death for Inheritance Tax.
Unfortunately for his children, HM Revenue & Customs may add the £100,000 back into their father's estate when calculating the Inheritance Tax payable, as he had qualified to be paid the money.
In the event if is added back into the estate, and assuming the rest of his estate was over the nil-rate band, these would be £40,000 tax to pay, being 40% of the £100,000 sum assured.
Therefore, Joe's children have, totally unnecessarily, lost £40,000 of the inheritance he had left them.
