The Finance Act 2006 is now with us. The 34 paragraphs in Schedule 20 are organised in six parts dealing with:
Trusts for bereaved minors, age 18-25 trusts and accumulation & maintenance trusts.
Interests in possession.
Related amendments in IHTA 1984.
Related amendments in TCGA 1992.
Property subject to a reservation.
Conditional exemption – relief from charges.
As well as being armed with knowledge about Schedule 20, advisers need to be aware of how the discretionary trust regime works in conjunction with inheritance tax.
For planners using financial products in estate planning strategies, there are quite a few additional issues to consider before deciding to take action.
With the increasing difficulty in lifetime planning to reduce the liability to IHT imposed by the gift with reservation rules, pre-owned assets tax and now the new trust alignment rules, it may be that more of those who are concerned about IHT will consider providing for much of the liability to IHT that cannot be reduced.
Before trust alignment, providing for the liability through an appropriate (usually last survivor) protection plan in trust was a relatively straightforward affair. The premiums were almost always exempt and the sum assured tax-free. Beneficiaries could be changed under a typical flexible trust and, where this change took place by way of appointment (usually but not always) by the trustees during the lifetime of the beneficiary being “disappointed”, the transfer would be a potentially exempt transfer.
On the death of a beneficiary with an interest in possession under the trust, the value of their interest would be included in their taxable estate on death. Whether a liability to IHT arose would be determined by the value of their interest in the trust, other transfers made on death and who the interest passed to under the deceased’s will, intestacy or the terms of the trust.
These consequences will generally continue to apply for pre-Budget trusts that are not amended so as to bring the new discretionary trust rules into play. As long as the beneficiaries are not changed (other than on their death) after April 5, 2008 and the trust policy is not varied outside of the contractual terms, the status quo will be maintained. If the policy is varied otherwise than under a contractual term, then there will be a need to go “deeper and down” (boom! boom!) into the discretionary trust regime.
Post-Budget policies held on other than bare trusts will be subject to the discretionary trust regime from outset. Premiums paid will still be exempt in most cases but when a periodic charge occurs, for example, on the first 10-year anniversary of the policy, there will be a need to ascertain the policy value at that time. This will be the value to which the appropriate rate will be applied. The value of the policy at the time of the 10-year anniversary will also be pivotal in determining the amount of the assumed transfer made by the assumed transferor for the purposes of the IHT calculation.
In most cases, where the policy value and cumulative total of transfers made by the settlor in the seven years immediately preceding the commencement of the trust are less than the nil-rate band at the time of the periodic charge, the rate on the assumed transfer will be nil and this, applied to the policy value, will result in no IHT being due. This will then buy IHT freedom for the trust for the next 10 years if there is no added property.
With most protection plans subject to other than bare trusts, there will be no entry, periodic or exit charge. But as others, including the Association of British Insurers, have pointed out, there could be occasions when the value of the trust fund could be meaningful and trigger a charge.
A much quoted situation would be where the life assured dies and the sum assured is held on trust, not having been distributed at the 10-year anniversary. Another is where the life assured is in serious ill health at the time of the periodic charge. I will look at this in more detail next week but, so as not to keep you in suspense, I can tell you that HMRC Capital Taxes has confirmed to us that the “not less than premiums paid” rule involving life policies for IHT does not apply in connection with policies under the discretionary trust regime.