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Ian Smart: Take care when writing life insurance policies in trust

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The problem: My client is looking to take out £500,000 of life cover to protect their mortgage. I want to make sure the proceeds are available as quickly as possible so I will suggest that the policy be written in trust. I have heard that changes are being proposed to the taxation of trusts. Is there anything I need to tell my client?

The solution: While changes to the taxation of trusts are about to be made, I believe that for most people the effect of these should not outweigh the need for the claim to be paid as quickly as possible. Even with the changes, most policies will not trigger a tax charge so this should really be the last consideration.

Under current legislation, it is possible to create several trusts on consecutive days and each will get its own nil-rate band. 

This makes it possible to avoid the periodic and exit charges that apply to most trusts by splitting the cover into several policies, each below the nil-rate band.

In this example, you could create two policies for £250,000 and write them in trust on consecutive days. 

Assuming no other chargeable lifetime transfers were made in the previous seven years, both trusts would have a full nil-rate band, making it unlikely that any periodic or exit charges would arise.

However, in his recent Autumn Statement, Chancellor George Osborne announced that the Finance Bill 2014 would make a change to this situation. That change had not been published at the time of writing but the final legislation is likely to be in line with the consultation issued by HM Revenue & Customs on 21 May 2013.

This proposed that instead of each trust getting its own nil-rate band, the nil-rate band would be split equally across all trusts created by the same person. The calculation would also be simplified: tax would be chargeable at a flat rate of 6 per cent on any amount over a trust’s share of the nil-rate band. Previous lifetime transfers and non-relevant property within the trust would be ignored.

These changes mean that for most people it is unlikely that there would be any benefit in splitting the plans in this way.

To make matters even more interesting, this will not just affect trusts set up after the change goes live. It is being done in the name of simplification and to avoid having a mix of trusts, some subject to the old taxation and others to the new legislation, it will also apply to trusts that are already in existence. The putting of a new life policy into trust could therefore affect the taxation of any other trust the client has already established.

For example, a client may have made a lifetime gift to the next generation using a discretionary trust. Until now, that trust would have benefited from its own full nil-rate band in calculating the periodic and exit charges.

 If an insurance policy is subsequently taken out and placed in trust, the first trust will now have only half the nil-rate band it used to. Tax may become payable at the next 10-year anniversary or if any of the assets are passed to a beneficiary.

The calculation of the tax may well have been simplified but the advice process has become more complicated, especially for those advisers with more wealthy clients.

Much more care will therefore be needed to establish whether your clients have any existing arrangements that will be affected when writing
a new policy under trust.

Ian Smart is head of product development & technical support at Bright Grey

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