North Wales Independent Advice How To Stop 40% of your life cover going to the taxman

CHANGES TO TRUST TAXATION RULES WERE MADE BY GORDON BROWN IN HIS 22 MARCH 2006 BUDGET.

THE INFORMATION GIVEN IN THIS SECTION RELATES TO THE PRE-BUDGET RULES.

DESPITE THE CHANGES MADE BY GORDON BROWN, THERE ARE STILL MASSIVE TAXATION ADVANTAGES TO PLACING YOUR LIFE COVER IN TRUST.

PLEASE CONTACT US FOR SPECIFIC ADVICE ON THE NEW TRUST RULES.

The information given below remains valid for life insurance policies placed in trust prior to 22 March 2006 and will therefore remain available.

Under certain circumstances, even policies placed in trust prior to 22 March 2006 may be caught by the new rules. For specific advice, please contact us.

All references to a “trust” in this and any other section refer solely to the type of trust known as an “Interest in Possession, Power of Appointment” trust.

All references to “policy proceeds” or “sum assured” refer, unless otherwise stated, to the payout in the event of death, of a life insurance policy which is in an interest in possession, power of appointment trust.

All references to “the policy” or “the life insurance policy” refer to any of the various forms of term insurance, none of which acquire a cash surrender or maturity value, and will only pay out money if an insured event, such as death or critical illness, occurs.

All references to the “insured person” unless otherwise stated, assume that the insured person and the policy owner are one and the same.

For the purposes of family life insurance planning, a trust is simply a recognised means of ensuring that, in the event of your death, the proceeds of your life insurance go to the person or people that you want, with the minimum of delay, and ideally, with no Inheritance Tax to pay on the amount paid out.

There are many different types of trust, but the Interest in Possession, Power of Appointment trust is, in our opinion, the one best suited for use in family life cover planning because of the many advantages, as outlined in this section, and unless there is an overriding reason not to, we recommend placing all life cover policies in an interest in possession, power of appointment trust.

As well as providing for the benefits to be paid out with no liability to Inheritance Tax, the proceeds of a life insurance policy in trust can be paid out without having to wait for Probate to be granted, which can sometimes take months.

If a life insurance policy is set up without the use of a trust, the policy proceeds will form part of your estate in the event of your death. This means that the Inland Revenue will take the life insurance payout into account in calculating any Inheritance Tax liability.

This is a problem because the whole of your estate, without upper limit, is liable to pay Inheritance Tax at a flat rate of 40% of the excess over £275,000. (Tax year 2005/2006).

As the value of your home will normally be taken into account, and bearing in mind the explosion in the value of houses in recent years, if your total estate is already over £275,000; any life insurance cover you have, if it is not in trust, will be added to your estate on your death, with the result that 40% of it could be lost in Inheritance Tax.

It is an unfortunate fact that many financial advisers, perhaps due to a lack of understanding, do not routinely recommend the use of a trust in family life cover planning, and it is probably fair to say that the vast bulk of life insurance policies in existence in the UK today are not in trust.

If this is the first time that you have heard of putting a "life insurance policy in trust" then it is probable that your existing life cover is not in trust.

If your existing life insurance cover is not in trust, there is a very real possibility that in the event of your death, your surviving family could lose 40% of the payout to the Inland Revenue in Inheritance Tax.

If your spouse does not survive you, it is virtually guaranteed that your children will lose 40% of the payout.

As mentioned above, Inheritance Tax applies if your estate goes over £275,000. This amount is known as the “nil-rate band”.

The “nil-rate” band is normally increased in the budget each year, but generally only in line with the Retail Prices Index. For example, in the previous tax year, 2004/2005, the nil-rate band was £263,000, so it was only increased by just over 4.5%.

Because house prices have risen so dramatically in recent years, more and more families are going to be affected by Inheritance Tax, and because the nil-rate band is only increased usually in line with inflation, as time goes by, even more families will be affected. Inheritance Tax is therefore no longer a problem just for the wealthy.

Any life insurance policies not set up in trust will fall into the estate and, if the rest of the estate is over the “nil rate” band will be taxed at 40% of the whole of the life insurance payout.

This means that if you have children, and have life insurance not placed in a trust, you could be unwittingly depriving your children of nearly half of the value of your life insurance cover.

The settlor, in the case of a life insurance policy being placed in trust, is the owner of the policy, known, unsurprisingly, as the policy owner. In “insurance speak”, the policy owner is also known as the grantee.

For life insurance policies placed in trust, the policy owner is almost always also the sole insured person.

The settlor appoints trustees. Depending upon an individual trust wording, the settlor may or may not automatically be an ongoing trustee.

If the wording of an individual trust form does not provide for the settlor to automatically become a trustee, the settlor simply appoints themselves as an ongoing trustee.

A trust provides for trustees to be appointed and for a beneficiary or beneficiaries to be named.

The trustees have total control over the trust assets, which in the case of a life insurance policy; will be the policy proceeds in the event of a claim.

Because of the power of control that trustees have, the settlor should exercise very great care in choosing whom to appoint.

The beneficiaries have no control over the trust assets; they are simply passive potential recipients.

It is possible for a person to be a trustee only, or a beneficiary only, or to be both a trustee and a beneficiary.

Only beneficiaries may benefit from a trust. If a person is a trustee, but not a beneficiary, they will be able to have power over the trust proceeds, but they themselves will never be able to benefit.

If a trustee is also a beneficiary, they may be either a default beneficiary or a potential beneficiary.

WHAT DO THE TERMS “DEFAULT BENEFICIARY” AND “POTENTIAL BENEFICIARY” MEAN?

A trust has two classes of beneficiaries; “default” (also known as “named”) beneficiaries and “potential” beneficiaries.

The default beneficiaries are deemed to be the “beneficial owners” of any policy placed in trust, and in the absence of the trustees appointing benefits away from them, will receive the proceeds of any policy in trust.

If there is only one default beneficiary, they own 100% of the policy proceeds. If there is more than one default beneficiary, they will each be deemed to own a specified proportion of the policy proceeds, normally an equal proportion, but, if required, it could be an unequal proportion.

If the trustees appoint the policy proceeds to the default beneficiary or beneficiaries, in the same percentages as the default beneficiaries are entitled to as stated in the trust deed, no liability to Inheritance Tax will arise.

A potential beneficiary is simply a person who may – if the trustees so decide - benefit from the policy proceeds.

If the trustees appoint the policy proceeds to a potential beneficiary or beneficiaries, this will count as a transfer away from the default beneficiary or beneficiaries, and could give rise to an Inheritance Tax liability.

The exception to this would be in the event of the trustees appointing benefits away from the default beneficiaries to the UK domiciled spouse of the insured person, either during the insured person’s lifetime, or within two years of their death. (For more information on this, please refer to the “Spouse Exemption” section below.

No. In the event of a claim, the life insurance company pays the claim proceeds to the trustees, who at that point choose which of the default and/or potential beneficiaries they will appoint a benefit to, and in what proportion.

If you remember the scene in “Oliver Twist” where Oliver, holding his bowl out; says to The Beadle “Please Sir, may I have some more?” and think of the trustees as playing the part of The Beadle, (deciding whether or not to hand out proceeds) and the beneficiaries as playing the part of Oliver, you may get the general idea.

Unlike Oliver, however; the beneficiaries have no right to ask. The trustees simply decide for themselves which of the beneficiaries receives a benefit, and if so, how much.

For example, if the insured person is survived by their spouse, and assuming the surviving spouse is a potential beneficiary; (which would normally be the case) the trustees can appoint 100% of the benefits to the spouse.

If the trustees apply the proceeds for the benefit of the “default” beneficiaries there would normally be no IHT liability, as the default beneficiaries are deemed by the Inland Revenue to have original ownership of the benefits, and there is therefore no element of “transfer” and therefore no Inheritance Transfer Tax due.

In order to avoid children having an IHT liability on the proceeds, we normally recommend – providing the parents are legally married to each other and are domiciled in the UK, - that their children be named as the “default” beneficiaries; a spouse would be named as a "potential" beneficiary.

In addition, providing there is a surviving trustee, children will not have to wait for probate to be granted and could receive the funds with minimum delay.

In the event that one parent does survive the other, they can receive the proceeds from the trustees, providing the recipient parent is a potential beneficiary.

If, instead of making an outright appointment of the proceeds to the surviving parent, the trustees were (assuming the trust wording allowed it) to make him or her an interest-free loan; a debt against the survivor's own estate would be created. This could result in a further IHT tax saving upon the survivor's ultimate death, as their estate would be reduced by the amount of the loan, which would then be repayable to the original trust.

CAN CHILDREN BORN AFTER A TRUST IS SET-UP BE ADDED AS DEFAULT BENEFICIARIES?

Yes, if you have any more children after the trust has been set up, their names can, and normally, should, subsequently be added as default beneficiaries.

This will be treated as a partial transfer from the other default beneficiaries, for example, a previously sole named child would have been a 100% beneficiary, but on the naming of a sibling would become a 50% beneficiary, along with the newly-named sibling.

This partial transfer of benefits will have no adverse IHT consequences, if the policy concerned is a form of term insurance, such as family income benefit, level term or convertible term, as these policies have no value except in the event of a claim.

(Technically, it would be a potentially exempt transfer, but as there is never any surrender value of a term type life policy, the amount transferred is zero, which is why it is of no consequence.)

However, the Inland Revenue may regard the policy as having a value if the insured person is in gravely poor health at the time of the transfer.

Therefore, it may be better not to make a change to the default beneficiaries if the insured person is in gravely ill health. However, this is a complex area, and we recommend that you contact us for advice before making any changes to the default beneficiaries.

WHAT IS THE INHERITANCE TAX POSITION IN THE EVENT OF THE DEATH OF A DEFAULT BENEFICIARY?

In the event of the death of a default beneficiary their share of the trust proceeds would count as part of their estate, even though the insured person may be alive, no claim has been made, and no life insurance actually paid out.

This means that if the deceased default beneficiary's total personal estate, including the value of their share of any life insurance policies in trust, exceeded the 'nil-rate band' (£275,000 in the 2005/2006 tax year), that Inheritance Tax could theoretically be payable.

However, assuming the life policy or policies are some form of term insurance, which normally has no surrender or encashment value, then unless the insured person is in gravely poor health, or dies at the same time as the default beneficiary, there will be no potential liability to IHT arising upon the death of a default beneficiary, as the policy would have a “nil” value.

Even if the policy has a value, either because the insured person is in gravely poor health, or in the event that the insured person has died, either before or simultaneously with a default beneficiary, then under the “spouse exemption” (explained in more detail below) if the trustees appoint the benefits of a deceased default beneficiary to the (UK domiciled) legally-married spouse of the insured person, there will be no liability to IHT.

Assuming that the insured person is alive and well, and that the policy therefore has a “nil” value for IHT purposes, and in the event of the death of one or more of the default beneficiaries, the trustees can appoint a new default beneficiary or can change the percentage to which the remaining existing default beneficiaries are “beneficially entitled” without any adverse IHT implications.

Technically, any changes made to the default beneficiaries are classed as a potentially exempt transfer, from the existing default beneficiary(ies) to the new default beneficiary(ies), but if, at the time of any change of default beneficiaries, the insured person is alive and in good health, it would be a transfer of “nil” value and therefore of no consequence.

Please note that if a new default beneficiary is appointed, they must be selected from the existing range of potential beneficiaries, it is not possible to appoint a default beneficiary from outside the range of potential beneficiaries.

Nor is it possible to increase the range of potential beneficiaries once the trust has been set up. Therefore, care should be taken to ensure that the range of potential beneficiaries is at outset, as wide as possible, to give maximum flexibility.

WHAT IS THE INHERITANCE TAX POSITION IN THE EVENT OF THE DEATH OF A POTENTIAL BENEFICIARY?

The death of a potential beneficiary will be of no consequence in respect of Inheritance Tax, as potential beneficiaries are not deemed to own any of the trust proceeds.

There is a provision known as the “spouse exemption” in the Inheritance Tax Act 1984 (IHTA 1984) which specifically allows for trust proceeds to be appointed by the trustees to the spouse of the insured person without giving rise to any liability or potential liability to Inheritance Tax.

This is provided the spouse to whom any benefits are appointed is UK domiciled and that the benefits are appointed to him or her either during their spouse’s lifetime, or within two years of their spouse’s death.

There is normally no liability to IHT if benefits are paid to a UK domiciled legally-married spouse. (“UK domiciled” simply means that you are ordinarily resident in the UK and that you intend to spend the remainder of your life in the UK.)

However, if there is no surviving UK domiciled spouse, the whole of the deceased person’s estate, without upper limit, over the "nil rate" band (£275,000 tax year 2005/2006) will be taxed at a flat rate of 40%.

(A spouse who is non-UK domiciled has an extra allowance, currently £55,000 on top of the nil-rate band before he or she would have to pay tax on the proceeds of their deceased spouse’s estate, but above that amount, the whole of the excess of the estate is once more, taxable at 40%)

(The domicile of the insured person is irrelevant. The 'spouse exemption' will operate if the recipient spouse is UK domiciled, even if their husband/wife - the insured person - is not UK domiciled.)

If the trustees appoint benefits away from a default beneficiary to any of the other beneficiaries, whether to another of the default beneficiaries, or to a potential beneficiary, such an appointment would normally be classed as a “potentially exempt transfer” (PET) from the default beneficiary or beneficiaries, concerned. This means that an IHT liability, possibly very significant, could arise in the event of the death of one or more of the original default beneficiaries, (from whom benefits have been appointed away, known as a 'dis-appointed beneficiary') within seven years of the date of the appointment away.

However, as explained above, providing the recipient spouse is UK domiciled, and assuming the trustees appoint benefits to him or her either during their spouse's lifetime or within two years of the date of death of their spouse, the “spouse exemption” guarantees that the appointment of benefits to the spouse will be a totally exempt transfer, and not classed as a PET. There would therefore be no possibility of any IHT liability subsequently arising in the event of the death of a 'dis-appointed beneficiary' within seven years of the appointment.

If, (as is usually the case) it is intended that children should receive the proceeds of any life policies in the event of the death of both of their parents, the children should be named as the default beneficiaries. The (legally-married, UK domiciled) spouse should not be named as a default beneficiary, but should be among the class of potential beneficiaries.

If there is no surviving parent, and assuming children are named as the default beneficiaries, they will be able to receive benefits without any IHT liability. If the (UK domiciled, legally-married) spouse is among the class of potential beneficiaries, and if he or she survives their partner they would, under the “spouse exemption”, be able to receive the benefits, with no liability whatsover to IHT.

It is important to note that partners who are "common-law" spouses, and are not legally married, do not benefit from the "spouse exemption".

Once a life policy has been placed in trust, the trustees assume control of the policy. The insured person cannot stipulate who will get a benefit in the event of a claim.

Nevertheless, we recommend that the insured person should include in their will a “statement of preference” that (e.g.) they wish their spouse to receive the relevant policy’s proceeds if their spouse survives them, but if their spouse does not survive them – perhaps by a number of days - to be paid to surviving children.

A “statement of preference” in the insured person’s will would not be binding upon the trustees of any life policies in trust, as the will dictates what should happen to the estate of a deceased person, and by placing a life policy in trust, the insured person is removing it from their estate. Nevertheless, a “statement of preference” would provide the trustees with valuable guidance as to the insured person’s wishes.

We recommend that you take advice from a suitably-qualified solicitor before including any such “statement of preference” in your will. The solicitor would be responsible for the arranging of your will.

You must not rely on these statements in drawing-up your own will, and we will not be responsible if you fail to accept our advice to consult a solicitor to draft a will.

Premiums for any life policy placed in trust must be paid out of a bank account in the sole name of the insured person.

If the premiums are paid out of an account held jointly with their spouse, this will invalidate the above “spouse exemption” and allow the Inland Revenue to add the value of the policies back into the estate for the purposes of “totting up” the IHT bill and therefore likely reduce the value of any inheritance for the beneficiaries.

This would mean that your children (assuming they are the default beneficiaries) may have a significant IHT liability if both parents should die, and would also mean that if a spouse should survive, and receives the policy proceeds, (as would normally be the case), that a liability to IHT, again, possibly significant, could arise in the event of the death of a default beneficiary within seven years of the appointment being made, even if the widowed spouse is UK domiciled and even if the benefits are appointed to them within two years of the death of their spouse.

Because of this, we always recommend that the premiums for any life insurance policy in trust are paid out of a bank account in the insured person’s sole name.

In the event you have decided to have the premiums paid out of an account held jointly with your spouse, this could lead to a large IHT bill in the future, as described above, and such a course of action is against our advice, and we will not be liable for any adverse Inheritance Tax or any other consequences arising as a result.

ARE THE PREMIUMS OF A LIFE POLICY IN TRUST THEMSELVES LIABLE IN ANY WAY TO INHERITANCE TAX?

The initial premium of a life policy in trust will fall within the annual exemption of £3,000 (2005/2006) - assuming the exemption has not been used-up in that tax year - or an additional annual allowance of £250 - with subsequent premiums falling within the "gifts out of normal expenditure" exemption.

The "normal expenditure" exemption will apply if it can be demonstrated that the gift was made as part of regular expenditure and was made out of income, and that the giving of the gift did not adversely affect the standard of living of the person making the gift.

It is apparent that if the premiums of a life policy in trust are paid annually, six-monthly, quarterly or monthly, that the ongoing regularity of the arrangement is clearly demonstrated, in order to satisfy the "gifts out of normal expenditure" exemption.

Assuming the policy is for death only, and is not a joint policy, we would normally advise mortgage life insurance to be set up in trust, with children as the default beneficiaries. This has several advantages.

In the event of one parent surviving the other, the policy proceeds can be appointed to the surviving parent, who can use them to pay off the outstanding mortgage. (Please refer to earlier section about the "Spouse Exemption.)

In the event that neither parent survives, the policy proceeds do not form part of the parent’s estate, which means that the outstanding mortgage remains as a debt against the remainder of their estate, and will therefore act to reduce the amount of the estate that remains liable to Inheritance Tax.

Needless to say, the reduction in the taxable value of the estate caused by leaving the outstanding mortgage as a debt against the estate is to the manifest benefit of the children, as it will mean a lower Inheritance Tax bill and a correspondingly bigger inheritance for them.

The trustees have a duty to use the proceeds for the benefit of the children (being the default beneficiaries) but it cannot be argued that paying off the outstanding mortgage with the proceeds of the mortgage life insurance policy and thus giving the children the continued right to occupy the family home is not to their benefit.

In addition, by placing the mortgage life insurance in trust, with children as the default beneficiaries, means that, providing there is a surviving trustee, the proceeds can be paid out without waiting for Probate to be granted, which could take months or in extreme cases, years.

Obviously, it is to the children’s advantage to have the money available to repay the outstanding mortgage as soon as possible, to reduce to the minimum the interest that would otherwise be accruing if the proceeds were “frozen” waiting for Probate to be granted.

No, the insured person, assuming they are also the policy owner, must not reserve any benefits for him or her self, including not reserving any “critical illness” and “terminal Illness” benefits the policy may contain.

(Terminal illness benefit is not to be confused with critical illness benefit, explained earlier. It is simply an advance payment of the death benefit, as it pays out if the insured person is diagnosed as having less than 12 months to live.)

Unless all policy benefits are given up, the Inland Revenue is likely to set aside the trust, and include the policy proceeds in the estate when calculating the amount of Inheritance Tax that the estate will have to pay.

However, from a practical point of view, it does not matter that the insured person gives up any critical or terminal illness benefits.

In the event of a claim for either of these benefits, the insured person’s spouse can be paid the benefits and so for example, if the policy was designed to pay off a mortgage in the event of death or critical illness and assuming the insured person has a critical illness, the spouse can receive the funds and thereby pay off the mortgage.

However, it may be preferable, depending upon your circumstances, to set-up any policy containing a critical illness benefit on a “life of another” basis.

If there are no children and no intention of having any, or in the case of the insured person having a non-UK domiciled spouse, it would usually be preferable to set up a policy with critical illness on a life of another basis. The policy proceeds would be directly payable to the policy owner in the event of a claim.

If the spouse for whom benefits are intended is not of UK domicile, then no policy should be placed in trust, (assuming the children would be named as the default beneficiaries) as the IHTA 1984 “spouse exemption” would not apply.

If the spouse for whom benefits are intended is not of UK domicile, it would normally be preferable for any relevant life insurance policies to be set up on a “life of another” basis, with the non-UK domiciled spouse as the policy owner.

This means that he or she would receive the proceeds free of IHT in the event of a claim.

If there are children, or an intention to have children, and assuming the spouses are both UK domiciled, it would usually be preferable to place a policy with a payout in the event of death or earlier critical illness, in trust.

Depending upon family circumstances and your wishes, it is possible to place a policy that would pay out in the event of death or critical illness in trust.

For example, if you are married with children, you could name your children as the "default beneficiaries" and your spouse as a "potential beneficiary". You, as the policy owner, would give up any right to receive the policy proceeds in all circumstances, including in the event of you being diagnosed as having a critical illness.

Set up in this way, and in the event both parents die, the proceeds will go to your children free of any IHT liability. If you die but your spouse survives you, he or she can receive the death benefit, again free of IHT liability. If you should not die, but have a critical illness, although you may not receive the proceeds, your spouse can and will then immediately be able to use the proceeds to (for example) pay off your mortgage.

By placing your life/critical illness in trust in the above manner, it will also have the additional benefit, in the event you should suffer from a critical illness that prevented you from dealing with your own affairs, that your spouse can receive the policy proceeds and use them immediately; again, for example, to pay off your mortgage.

An alternative to placing a life/critical illness policy in trust as described above would be to set it up on a “life of another” basis – which simply means that the insured person and the policy owner are not the same person. (Usually the policy owner would be the spouse or partner of the insured person.)

In the event of a claim on a policy set up on a life of another basis, the policy owner can, in the event of a claim, receive the proceeds quickly and with the minimum of “fuss”, whether the the insured person has died or had a critical illness. However, in the event of the policy owner not surviving the insured person, the policy proceeds would form part of the policy owner's estate and would be liable to Inheritance Tax.

It would therefore normally be preferable to set up your life/critical illness cover in trust, as described above, so that if your spouse should not survive you, your children would be able to receive the proceeds free of liability to IHT.

WHAT ABOUT “SPLIT TRUSTS” – DON’T THEY MEAN I CAN RESERVE A PAYOUT FOR CRITICAL ILLNESS FOR MYSELF AND STILL LEAVE A DEATH PAYOUT IN TRUST FOR MY CHILDREN?

Some advisers recommend the use of a version of an interest in possession trust that retains the critical illness benefits (assuming the policy has such benefits) for the insured person while placing the death benefit in trust.

With the exception of being used by a single parent, as explained in the next section, in our opinion this form of trust is dangerous and should be avoided. Here’s an example scenario:

Let’s assume that the insured person is a father and has a £100,000 policy which will pay out on the first event of him either being diagnosed as having a named critical illness or upon his death.

He wants to reserve the £100,000 in the event he suffers a critical illness for himself, but he wants the money, in the event of his death, to go to his children, ideally without any liability to Inheritance Tax.

He sees an adviser who says this can be done by means of something called a “split trust”, and the policy and “split trust” are then set up.

As this is one of the named critical illnesses, he immediately qualifies to receive the full payout from his policy.

However, he chooses not to inform the insurance company, because he has decided not to claim, having been told by the doctor that his life expectancy can now be measured in days or weeks.

A claim is now submitted to the life insurance company for the full sum assured, which is payable, as the policy covered against death or 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 (IHT).

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, the Capital Taxes Office, (which is the department of the Inland Revenue that is responsible for collecting IHT) discover that their father had qualified to be paid, by virtue of his earlier heart attack, the full policy proceeds while he was still alive, and by not taking the money, he had deprived his estate of the full amount to which he was entitled, which would be the full £100,000 cover of the policy.

Unfortunately for his children, IHT is due on the total amount of the estate at the time of death, (plus any life insurance payouts as a result of the death, if these are not in an effective trust) and any other sums to which the estate was entitled, including the full £100,000 of the critical illness sum assured, even though he had not actually claimed it.

Taking into account the value of their father’s home and his other assets, if the remainder of his estate is already over the nil-rate band, his children would be left with only 60% of the policy proceeds, as the Inland Revenue will want 40% of the £100,000 sum assured to be immediately paid in Inheritance Tax.

Therefore, the children have totally unnecessarily, lost £40,000 of the inheritance their father had left them.

I AM A SINGLE PARENT, CAN I USE A "SPLIT TRUST" TO RESERVE CRITICAL ILLNESS COVER FOR MYSELF AND LEAVE THE DEATH BENEFIT FOR MY CHILDREN?

As a single parent, you have no spouse whom you could name as a "potential beneficiary" to receive the policy proceeds if you should die or have a critical illness.

You could therefore use a split trust to reserve the critical illness payment for yourself and leave the death benefit for your children.

If you do this and if you have a critical illness, you can receive the policy proceeds, as you have not given up the payout in the event of a critical illness.

If you die, from a "non-critical illness related" cause, (for example, a road traffic accident), your children should be able to receive the policy proceeds free of any liability to IHT.

However, if you were to die from a "critical-illness related" cause, (heart attack, cancer, stroke, etc.) it is likely (even if you die before making a claim) that the policy proceeds will be counted as part of your estate by the Capital Taxes Office and would therefore be liable to IHT.

Nevertheless, if you use a "split trust" in the above manner, at least your children have the possibility of being able to receive the payout free of IHT; whereas if your life/critical illness cover is set up without using a trust, the proceeds will, in the event of your death, definitely form part of your estate and therefore liable to IHT.

DOES PLACING A LIFE INSURANCE POLICY IN TRUST PROVIDE ANY PROTECTION FROM CREDITORS?

Placing a life policy in trust means that the proceeds, in the event of a claim, are more likely to be beyond the reach of any creditors.

However, an Interest in Possession, Power of Appointment trust does not give total security from potential creditors.

If 100% protection of the policy proceeds from potential creditors is required, then life insurance must be set-up under a Married Women’s Property Act 1882 (MWPA) trust.

(You may ask, if an MWPA trust gives 100% protection from creditors, why not set up all life insurance policies under an MWPA trust?)

The answer is that an MWPA trust is extremely restrictive in the range of beneficiaries.

Only a legally-married spouse, (despite the "Married Women's" name, under an MWPA trust, a husband, as well as a wife, can be a beneficiary) or children (including illegitemate and adopted children, but excluding step-children) can be beneficiaries under an MWPA trust, no other persons can ever benefit.

On the other hand, use of an Interest in Possession, Power of Appointment trust can allow for literally anyone to be named as a beneficiary.

All trustees must agree unanimously in deciding which beneficiaries may receive benefits, so the settlor should exercise great care in their choice of trustees.

A trust must have at least two trustees at outset, so it would usually be the case that the settlor appoints their spouse/partner as the first additional trustee. The power to appoint further trustees then rests with either the settlor on their own, or the ongoing trustees, according to the individual trust wording.

In order to avoid Probate delay, it is wise to appoint a third trustee in case of the death of both of the two original trustees. A family member or friend may be chosen as a third trustee, or a solicitor or a trust corporation. A trustee must be at least 18 years of age, and of sound mind.

For example, you may decide to appoint as trustee, the person you have appointed, in your will, as the guardian of your children. In many cases, this may be the ideal solution, as the guardian would not have to constantly consult another party in regard to accessing trust funds for the benefit of your children.

However, there may be an overriding reason why you would not wish your appointed guardian to also be in control of the trust funds, and in this case, it may be better to appoint a solicitor as the additional trustee.

(If you were to appoint a solicitor as the additional trustee, they would be entitled to be paid fees from the trust funds for any professional duties carried-out.)

If you have any policies in trust, but have not yet appointed an additional trustee or trustees, please contact us without delay to arrange for an additional trustee to be appointed.

If you are concerned about any of the points raised, and perhaps suspect that your present life cover arrangements may be at the mercy of the taxman, please contact us for a review of your family life insurance, without any commitment or obligation on your part. Call us on 01978 313420, complete the contact form, or E-mail NWIA.