05 October 2015

The information contained within the following news articles have been pre published. The articles were published on the dates indicated and the information contained within these issues include references to taxation, legislation, regulation and other issues or concerns that may no longer apply

Sometimes it’s easier to simply pay the tax


With a variety of Inheritance Tax (IHT) planning schemes available, the main problem people face is that they normally involve giving away access to their assets, and in the modern world with people living longer and cost of living rising, it may be difficult to know how much you will not need access to in the future.


The good news is that you may not have to.  An alternative to giving away large sums of money, either to family or via trusts, is simply to pay the tax but have an insurance policy to provide the funds to do so.  This way, the taxman still gets what they want, you still have access to your assets and your family don’t lose out, as your estate isn’t reduced.  This type of planning still provides extremely good value in the vast majority of cases.


The life assurance benefit still needs to be written into trust, otherwise it will simply increase the value of your estate.  There are two types of trusts you can use – Absolute Trust and a Discretionary (settlor excluded) Trust. 


I have set out below the various issues that need to be considered when using life assurance policies for IHT planning.


Firstly regular premiums of up to £6,000 a year are normally exempt for IHT purposes as both husband and wife have an annual allowance of £3,000.  This assumes they haven’t used their annual allowances for any other gifts.


If the premium is greater than £6,000, or the annual allowances have already been used, then it may be possible to claim exemption using normal expenditure out of income rules.  This could only be done if the payments are regular, do not affect your standard of living and are out of income. 


As IHT is only ever charged when assets pass down a generation, it is usual for a husband and wife to set up their plan on a joint life second death basis.  This means the sum assured is only paid on second death which is when the IHT would be payable. Assuming a suitable trust is used then the sum assured will be outside the estate for IHT purposes. 


As two people (settlors) have created the trust, the trust will be treated as having had two settlements and therefore will benefit essentially from 2 Nil Rate Bands (NRB – being the amount of an estate that doesn’t pay IHT) for the purposes of calculating any periodic charges, see later.


On setting the policy up, as mentioned earlier premiums may be exempt via the annual allowance or normal expenditure.  If the premiums are not exempt then they would be regarded as chargeable lifetime transfers (CLT’s).  If the amount of CLT’s plus any CLT’s made in the last 7 years exceed the NRB (currently £325,000 for 2011/12), then there will be no immediate tax charge but it will reduce the available NRB for the next 7 years.


The trust will also be subject to both an exit charge and 10 yearly periodic charges.  If both lives assured were to die within the first ten years and the trust fund was distributed then there would be no additional tax charges.


However if both are still alive after ten years, the periodic charge will be based upon either the market value of the policy or the total premiums paid.  This value would then be added to any other CLT’s the couple have made and set against the Nil Rate Band. Therefore assuming the couple are in good health and have made no other CLT’s it is likely that there would be a nil 10 year periodic charge.


However as I have hinted above by saying the clients were in good health, if this were not the case then the calculation may be different.  For example if one of the lives assured had died and the other was now in ill health, the value of the life assurance policy is likely to be much greater than the premiums paid (as it may be paying out benefits sooner).  The value of the plan will depend upon the health of the remaining life assured and could be anything up to the actual sum assured.  If this is still below the two Nil Rate Bands (assuming two settlors of the trust) then there would still be a nil 10 year periodic charge.  There would also be no exit charge if death occurred before next 10 year periodic review and the trust benefits were paid out before then.


The periodic charge is effectively 30% of the lifetime charge of 20% which equates to 6%.  If we assume that at the 10 year review a trust had a value of £400,000 and an available Nil Rate Band of £325,000 then this would create a taxable amount of £75,000.  The lifetime charge on this would equate to £15,000.  £15,000 is 3.75% of the trust value.  As the periodic charge is 30% of the lifetime charge this would be 1.125% of the trust fund resulting in a tax charge of £4,500.


If we assume the remaining life assured dies after a further year and the trust fund is then distributed the exit charge would be 6% of the trust fund value multiplied by the number of complete quarters since the last periodic charge (4) divided by 40 which would be £450.


So the trust has paid a periodic charge of £4,500 and exit charge of £450.  In total this represents 1.2375% of the trust fund which I am sure you will agree has a minimal impact on the overall benefits of this type of planning.  As you can see there are many things that need to go against you for any tax to be payable and even when it is payable the tax isn’t as much as you may think.


You might say that is all right for smaller policies but what if you had a liability of say £1,000,000.  The Rysaffe principle was established in a court case a number of years ago for this exact scenario.


Appliying the Rysaffe principal simply means we establish several life assurance policies on different days which all ad up to £1,000,000.  For example you could have 5 policies each with a sum assured of £200,000.  Provided the policies are set up and trusts established on different days each will have it’s own Nil Rate Band for calculation of 10 yearly periodic charges and exit charges.


With regards to the entry charge, the settlor(s) will still only have a NRB each although as mentioned there may be other exemptions available.


Paul Dixon
Chartered Financial Planner

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