Last week, I started to look at the fundamental use of trusts in financial planning by considering the traditional phrase “right money, right hands, right time”. I suggested that it could often (or even usually) be held to be professionally negligent for a term insurance policy to be effected except under trust.
This latter point revolved primarily around the IHT liability which can arise if the death benefit from a policy falls into the life assured's estate rather than being paid directly, under a trust, to his nominated beneficiaries.
Right money, then, could be said to be an appropriate level of death benefit paid without deduction or liability of any form of taxation (otherwise the appropriate level of benefit becomes significantly inappropriately reduced).
In this article, I will continue to look at simple term insurance policies but in later weeks I will expand this discussion to financial planning products generally.
Taxation benefits are only one of the possible benefits of trusts, of course. But before we move on to slightly more complex issues, it is worth noting a second fundamental benefit of placing that term insurance policy in particular, but other financial services products in general, under trust – the ability for the policy owner to ensure the payment is made to the people of his choice.
Moreover, usually (I will clarify this point in a later article) the trust provisions will enable that policy owner (though in the guise of a trustee, rather than as the original policy owner) to amend the nominated beneficiary as often as he or she desires. This means that the policy benefits can be directed, in this respect, to the right hands, being the person of the policyholder's ongoing choice.
The same result may be achieved by the policy benefits falling into the deceased's estate and passing to nominated beneficiaries through his will but that, of course, will result in the IHT liability noted above if the deceased's estate exceeds the threshold. More about the selection of beneficiaries next week.
Finally, then, we can add right time to right money, right hands by noting that where the life policy has been effected in (or subsequently transferred to) a trust, the death benefits are payable from the life insurance company to the trustees of the policy, thence directly to the beneficiaries under the trust without the need to wait for probate to be granted – which can frequently take some months or even years.
This means that the benefits can reach the beneficiaries within days – a speed which cannot be matched where the benefits are paid to the dec-eased's estate, whether or not the deceased has made a will. So, right time means the speedy payment to the beneficiaries at the time when the money is most needed – in this initial example, on the death of the life assured.
The phrase right money, right hands, right time starts to describe, then, the very real and significant benefits to be gained by the fundamental use of trusts in financial planning. But it is essential that advisers do not lapse into believing that any trust will do.
Moreover, it is at least equally essential that the adviser understands the importance of the correct and appropriate completion of the trust form and a proper consideration – and explanation to the client – of the terms and provisions within the trust.
We start here by looking at the parties to a trust and how these should be selected by the person establishing the trust. The main parties to the trust are: the settlor, the trustees and the beneficiaries. It is important for financial advisers and their clients to understand the duties, rights, powers and liabilities of each of these parties to ensure that any trust effected will work to the maximum possible benefit for all.
First, the settlor. This is the person or persons who establish the trust and, typically, transfer assets in to it. With life insurance policies this will usually be the policyholder or, if the policy has not come into force, the policy proposer.
Most often the trust will be established simultaneously (well, almost) with the policy coming into force. But existing policies not already effected under trust may be transferred into a trust at a later date. This will be a major consideration of a future article in this series.
I suggest that the most important fundamental aspect of the role of the settlor is that, once that settlor has transferred assets into the trust they no longer belong to him and he completely loses control over that asset. Control passes to the trustees.
It is a common misconception among advisers and clients that the settlor, having been the original owner of the asset being transferred to the trust, retains control over the app-ointment and dismissal of trustees and beneficiaries.
I have been continuously aware for many years that there is quite a widespread belief that the settlor can, if he subsequently feels the trust he has established becomes inappropriate, simply abandon the trust and reclaim the assets he had previously transferred. This is not true. The assets transferred to the trust then belong to the trustees and can only be dealt with by the trustees – and then only within the provisions of the trust.
It is crucial that the client understands that unless the terms of the trust permit the transfer of the life policy or other asset back to his control (as will almost invariably not be the case) then he will completely lose control and ownership of that asset – at least in his capacity as the settlor.
I added that caveat as the client will almost invariably seek to retain some control, if not ownership, of the asset and will therefore appoint himself as one of the trustees.
This brings us on nicely to the second of the three main parties – the trustee or trustees. They are the people who have legal ownership of the trust property and must control and deal with the trust assets within the provisions of the trust wording.
Trustees are almost invariably given huge powers and discretions over the use of the trust and in many trusts have the power to determine and change the beneficiaries under the trust – without consultation with the settlor.
Moreover, trustees determine the nomination of future trustees – perhaps to add to or replace existing trustees. They may, in certain trusts, dismiss some of their own number.
As I noted above, it appears that a number of advisers believe that the settlor has the power to nominate and dismiss trustees – wrong. If the settlor seeks those powers he must nominate himself as a trustee.
It is the settlor who nominates the initial trustees and it is crucial that he takes great care in these nominations. As we will discuss at some length next week, great damage can be done to the settlor's interests if he initially appoints one or more trustees who subsequently prove unsuitable or undesirable.
Perhaps, before that article, you could give some thought to the features of a perfect trustee and also consider what you might think to be the perfect number of trustees for a typical trust in which a life policy is held.