The taxation of trusts written for whole of life policies can easily be reduced. Ian Smart explains the Rysaffe Principle.
For term-based life policies, the basisof valuation at the ten-year point is the market value of the policy. As term policies do not accrue a surrender value, the only time a charge might be payable is if the market value was higher than zero (due to the ill-health of the life assured) or following a claim (if the proceeds remain in the trust for future distribution to the beneficiaries).
For whole of life policies (either term based or unit linked), the basis of valuation at the ten-yearly point is the greater of the premiums paid and the market value of the policy. It is assumed that, after ten years, the NRB is £400,000 in 2018-19 and there have been no other previous CLTs other than those shown. The examples on tables one and two are based on approximate premium rates for a male non-smoker who is 55 years old and in good health for a Skandia Protect guaranteed whole life policy.
The result from the scenarios is that we have created, in Scenario 2, a series of trusts where there are no ten-yearly periodic or exit charges. This is compared with Scenario 1 where there may be tax to pay at the tenth and each subsequent anniversary and any future exit from the trust.
This planning may not be suitable for all your clients. However, when reviewing their needs for immediate and future planning strategies, it can offer a clear benefit where the trust is expected to be managed for a significant period. This can be, for example, to cover the owner of a business until retirement or beyond.
Ministers can alter legislation and HMRC practice can change at any time. You need to take care at the implementation stage to ensure the right trust is set up at the right time. Where a CLT is created above the current reporting levels, advisers need to complete three sets of forms (IHT100, IHT100a and supplementary forms depending on assets).
Significant growth in trust values may mean one or more of the trusts suffers ten-yearly periodic charges and consequently exit charges may apply. If NRBs continue to increase only in line with inflation or below, this could happen. Product pricing may be adversely affected, i.e. premiums may be higher for protection policies due to varying mortality rates and policy fees.
This type of planning will not suit every client, but it adds a level of planning which may well be suitable for high net worth individuals looking to create long-term strategies. It is worth remembering in both the PET and CLT regimes, you can give away your NRB every seven years.
ENTRY AND TEN-YEAR CHARGES
The scenarios explained from tables three to six focus on entry charges and the ten-year periodic charge. The conclusion from them is that we have created a series of trusts where the periodic charges are now £0 and any future distributions in the following ten years will also be taxed at this rate. This compares to table five, where there is tax to pay of £16,560 at the tenth anniversary. There will also be tax on any future distributions of capital in the following ten years.
But it has long been known that HMRC was not happy with the court decision to treat the trusts in this way. In his recent Budget, George Osborne announced that he is to consult on changes to the periodic charges on relevant property trusts in order to simplify them.
What the government is actually intending here, we will need to wait and see as the consultation document is not due to be published until June. But it may be that HMRC sees this as an opportunity to close this ‘loophole’ or reduce opportunities to cut inheritance tax liability.
One possibility is that it redefines related settlements under Section 62, so that a related settlement does not have to be created on the same day. A longer period could be used, such as the seven-year period for accumulation of CLTs. It is unlikely that the charges will be abolished completely or that in the current climate, the Chancellor intends to reduce tax receipts any further.
Any significant reduction would make it uneconomic to continue to collect the tax and in most people’s minds is likely to be seen as looking after the rich. That is despite the fact that many more people, than those who currently benefit from it, could benefit if they knew about it, and they do not need to be particularly wealthy.
Changes such as this normally affects only new arrangements. But it is not beyond the realms of possibility that any change would be at least partially retrospective.
To have any chance of securing the current treatment, advisers must take action by writing clients’ policies in trust before the next budget. They could use this opportunity to talk to clients, before recommending multiple smaller policies.
Existing plans can also be placed in trust and advisers can use the opportunity to build new relationships through introductions to whoever is to be appointed as trustee. Having an understanding of the current legislation and an awareness of the desire for change can be a powerful tool in any adviser’s armoury.
Ian Smart is head of product development and technical support at Bright Grey & Scottish Provident
