It is well known that the relevant property provisions (also known as the discre- tionary trust regime) now apply to these trusts if they were established on or after March 22,2006.
This has undoubtedly diminished their use since that date. However, these trusts were undoubtedly the “trust of choice” for those wanting to carry out estate planning with life insurance policies before that date.
Regardless of whether the policy in question was a protection plan or an investment-based product (such as a UK or offshore bond), the flexible interest in possession trust was the one that was invariably used.
Why? Well, for inheritance tax purposes, this trust was not affected by the relevant property provisions. This meant that one did not have to consider entry, periodic or exit charges as you would for a fully discretionary trust.
This tax “benefit”, by virtue of the non-application of the relevant property regime, was particularly valuable where the policy had significant value.
The reason why the relevant property regime did not apply was because a beneficiary or beneficiaries had an interest in possession – the current right to current income under the trust.
The fact that when the only asset of the trust was a life insurance policy the trust produced no income was irrelevant. There merely had to be the right to any income that could arise under the trust.
Despite the non-application of the relevant property regime, the flexible interest in possession trust could nevertheless confer a power to appoint or change beneficiaries.
Typically, this power would be vested in the trustees or the settlor. It was this flexibility to change beneficiaries without the need to consider the relevant property regime that made the flexible interest in possession trust so attractive.
Of course, as a conse- quence of having an interest in possession, a beneficiary was deemed to have such proportion of the capital value of the trust fund as corresponded to his proportionate right to trust income included in his taxable estate for inheritance tax purposes.
This would mean that if, say, there were two beneficiaries each entitled to 50 per cent of the trust income and the trust fund was comprised of an investment bond worth £100,000, each of those beneficiaries would have £50,000 deemed to be included in their estate.
This was a pure hypothesis for inheritance tax purposes but a very important one.
Interestingly, this hypothesis also applied where (more typically, under a will trust) there was a bene- ficiary or beneficiaries who had the right to trust income for life with the capital value of the trust fund going to another or others on their death.
For example, to a surviving spouse for life with the remaindermen being the testator’s children. In that case, even though the respective interests of the children and the surviving spouse carry real value (which could be realised if, say, there were a partition of the trust) for inheritance tax purposes, the whole of the value of the trust would be attributed to the interests of those with the right to income.
This would mean that if a remainderman died before those with the right to income there would be no value included in the remainderman’s estate for inheritance tax purposes.
Returning to my main theme of life insurance trusts though, with the extension of the relevant property regime to any flexible interest in possession trust established on or after March 22, 2006 (and in some cases to pre-March 22, 2006 trusts that are amended – more on this later – the hypothesis of the attribution of the capital value to a beneficiary with an interest in possession no longer has to be made.
Under the pre-March 22, 2006 provisions (which continue to apply to all unamended pre-March 22, 2006 interest in possession trusts), the fact that the beneficiary with the interest in possession would be deemed to have an interest in trust capital for the pur- poses of inheritance tax means there would be consequences if that beneficiary’s interest in possession ceased for any reason.
For example, if the power of appointment was exercised then, even though they had no control over this, the “disappointed” beneficiary would be treated as making a potentially exempt transfer for inheritance tax purposes equal to an appropriate proportion of the trust capital.
Similarly, if a beneficiary died with an interest in possession, then the capital value of that beneficiary’s interest for inheritance tax would be included in their taxable estate.
In both cases, the normal exemptions could be applied if appropriate.
For example, if, on an appointment of benefits during the lifetime of the interest in possession beneficiary, the new beneficiary was the spouse of the disappointed beneficiary or the spouse of the settlor, the deemed transfer would be exempt.
All of this is still relevant and important information for advisers whose (many) clients keep their pre-March 22, 2006 trusts intact.
I will continue my look at these provisions and consider the pros and cons of flexible interest in possession trusts under the new relevant property regime next week.