Life Policies – the Democratisation of the use of Trusts
It is a not often discussed point that insurance company life policies and investment bonds are well suited to be used with trusts.
Many people, who otherwise would not have had access to trust planning, can invest into trusts to provide insurance protection in trust. In this way life policies have truly democratised trust planning for a large proportion of the UK populous. Does this sound far fetched? This short article will try to explain how it is so.
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For example, an insurance bond, as a non-income producing asset, can be invested in a discretionary trust without the need to register for income tax returns with HMRC. This has the advantage that it saves greatly in ongoing tax and reporting costs. This is particularly valuable where the trust fund is not large and where these ongoing costs would otherwise make a trust prohibitively expensive.
Furthermore, within the bond the fund can be easily segmented, to represent the separate interests of later beneficiaries. This makes it easier to apportion withdrawals and growth between different beneficiaries who may have very different growth objectives and tax status. The flexibility of the investment options available within a bond provide a serious advantage. A bond wrapper can hold in a wide range of unitised funds, so enable diversification that would not be possible to other classes of assets such as cash and direct shareholdings – and these can easily be separated out within a bond for competing beneficiaries.
Perhaps the most valuable advantage of the bond is the ability to postpone the point of any tax charge to that most suitable to the trust beneficiaries. For example if fund switches were to be beneficial to the trust, say from unitised equity funds to cash., at a time when a market fall was occurring, non-bond wrapped assets would suffer a tax crystallisation point at such a sale. This often stops actions being taken with trust funds that would otherwise be beneficial. In a bond wrapper however, there are no charges and certainly no tax point on switching between funds and from funds to cash. This is a significant advantage.
The tax advantages do not stop there. At the time when the funds are to be distributed to a beneficiary, they may be segmented out and assigned to that beneficiary – again with no tax crystallisation point. This is extremely useful where the settlor is a higher rate tax payer, or where the beneficiary is a basic or non-tax payer. This is because the bond, or bond segments, that has been assigned can be encashed at the marginal rate of that beneficiary. As the tax on trust assets is soon to be 50%, compared with only 20% in the hands of a basic rate tax paying beneficiary, this can represent a significant saving.
Please note that once assigned the beneficiary may hold or encash at their choice. It is their asset – that has yet to have a tax crystallisation. Furthermore, the bond can access any unitised investment a trustee could wish to make onshore, or offshore. A good Independent Financial Adviser (IFA) is required to identify the best choice of bond wrapper provider, with the widest range of options.
There are many other, more subtle, investment and tax advantages of bonds. These are beyond the scope of this article, though the message is that bonds can easily be settled on trust, and easily assigned from trust, and also enable considerable investment flexibility. This is very valuable when annual trustee investment reviews are required, demonstrating diversification and regular review in a cost effective manner.
These advantages and the ready availability of life office pro-forma trusts and deeds of assignment have over the past two decades brought trust planning increasingly within the reach of the wider population. Most life offices have very well qualified and experienced trust departments who devote their efforts solely to the use of their trusts with their life offices’ products. This is for both bonds or protection insurances.
Innovations using bonds in Trusts – Discounted Gift Trust (DGT)
This has also led to some great innovations: discounted gift trusts and loan trusts, again using insurance bonds, to name but two which are the subject of other articles. They allow a further set of benefits for the settlor, trustee, and beneficiary.
However, the options do not have to be as complex as the DGT . Life Office pro-forma trust deeds most commonly enable a simple gift to trust at what is effectively no additional cost to the investment or insurance. For good or ill, a democratisation certainly.
These same life office departments also design a wide range of pro-forma trusts for use with life policies. Most commonly these are to prevent death proceeds falling into the estate of the deceased for IHT mitigation purposes. They can also be used to receive benefits for other purposes, such as sheltering proceeds from an errant adult child, or from full control of a surviving spouse, for instance.
Again these trusts can be used at no extra cost. They are readily available from nearly all life offices, with step by step guides on their completion. Indeed, it is a fact that hundreds of thousands of people have employed these trusts whilst taking no advice from a qualified legal practitioner. Again, for good or ill, this is democratisation.
On many occasions the writer has come across life policies which are not in trust, and it is a simple matter to place them in trust, should the circumstances merit this. This can stop a life policy being subject to a 40% tax charge a few years hence.
A high street legal practitioner can draft a similar simple trust but in the majority of circumstances it is not commercially viable to do so. It is usually better for a legal practitioner to draft the trust when there are many policies with different life companies which can all be assigned into one trust.
As for discounted trusts, and the more complex types of life office trust, hardly any high street law firm could offer a similar service, and even the larger private client firms cannot commercially offer it for settlements of anywhere near the average size of a discounted gift settlement: £75,000. This is why virtually no law firm does offer a DGT service.
Clients are faced with a variety of trust options from life offices, for their protection and investments. Law firms are often only brought in to advise after these have been set up. For the vast majority of such cases these trusts add great value, and at very low, or nil, additional cost. For good or ill, life office trusts have democratised this area of practice, once solely the domain of the legal practitioner.
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