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Critical strategies

The opening article of a mini series on critical-illness insurance

Critical-illness cover, like ordinary life cover, is signifi-cantly undersold/ under-advised in the UK.

Where it is bought on a stand-alone basis for personal protection, a trust will rarely be appropriate.

After all, the cover is bought by the life assured to be paid out to them if they suffer a defined critical illness. Yes, if they were to die with benefits unspent, their taxable estate for inheritance tax would be increased but this is a risk most seem prepared to accept or are unaware of.

Where CIC is bought inside a policy that also provides pure life insurance though, it may well be that a trust may enhance the benefit that the product delivers.

Provided that the policy terms are appropriate (and experience shows that this must be carefully checked), a trust that provides, broadly speaking, that the death benefit will pass to specified beneficiaries (or such beneficiaries from a stated class(es) as the appointor decides) and any critical illness benefit will be paid to the life assured, could be used.

It is important, though, in order to avoid a gift with reservation, that the combination of the policy and the trust is such that the benefits payable to the beneficiaries do not vary by reference to the benefits payable to the life assured.

It seems that as long as the benefits paid on critical illness totally extinguish the death benefits or leave them completely unchanged no GWR will arise.

The trust to which the death benefits is subject could be on a bare, discretionary or flexible basis. When it is known who is to benefit, and a change of mind is not envisaged, then the bare trust will be appropriate.

It also has the added advantage of avoiding having to consider the relevant property (discretionary trust) regime. Not that this will often be that detrimental in connection with protection plans but in some cases it could be so, if a bare trust facilitates what is wanted, avoiding the RPR is no bad thing.

The critical-illness benefit under a typical “split trust” would be held (carved out) for the absolute benefit of the settlor/life assured. In effect, then, there would be two trusts in a single trust document.

Regardless of the type of trust used for the death benefits, in practice, the whole of the premium paid to such a policy would be treated as a gift for IHT purposes but, in most cases, the normal expenditure out of income and/or annual exemption would apply.

Where the death benefits are held on a bare trust there will be no need to consider the periodic charge or the exit charge. If death occurs, and on the assumption that the GWR provisions have been successfully avoided, the benefit will be paid tax-free.

If the death benefits are held on other than a bare trust (which will most usually be the case), then it will be necessary to consider the periodic charge and the exit charge. However, these charges will rarely cause a problem.

A periodic charge could arise if the life assured were in serious ill health at the time of the charge or the premiums paid (if the policy were other than a term policy) were significant.

A periodic charge could also be relevant if the sum assured had been paid to the trustees and retained by them, say, because the beneficiaries were still quite young.

But even in these circumstances the value of the trust property would need to exceed the nil rate band available to the trust for a charge to tax (at 6 per cent on the excess over the available nil-rate band) to arise.

An exit charge in the first 10 years of the trust’s life would be a virtual impossibility and an exit charge after the first 10 years could only arise if there had been a periodic charge at the time of the last 10-year anniversary.

All in all, then, one can be tolerably happy that the risk of charges to IHT are quite low even if a non-bare trust is used for the death benefits.

For big policies, with substantial sums assured, it might be worth considering a multiple policy, multiple trust strategy (with the policies and trusts established on different days) in order to minimise or avoid the risk of any charges arising by effectively ensuring that each trust had its own nil-rate band.

If an individual had an existing policy providing benefits on death or earlier critical illness and this was not in trust, then if the life assured thought it were a good idea they could consider declaring a trust of the policy.

When an existing policy is made subject to trust, the value of the gift will be the market value (that is, generally the surrender value) of the policy (or, for other than a term policy, the premiums paid to date if greater).

This value, if there were one, would need to be discounted to take account of the value of the “retained” critical illness benefits held on bare trust for the life assured.

Of course, if the life assured were in serious ill health (but no criticalillness benefit had been paid) the value of the policy for IHT purposes could be significant and there is unlikely to be any IHT benefit to be secured from transferring the policy into trust.

A split trust will rarely be appropriate when an accelerated death cover (combined CIC/life cover) policy is used to provide the funds to help with business share purchase and I will look at this subject next week.

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