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Matters of interest

This weeks’s instalment on transitional serial interests turns to life policy trusts

Having considered two transitional serial interests and the transitional rules for accumulation and maintenance trusts, it is now time to turn to the special rules for pre-Budget life policy trusts. This TSI applies in addition to those described in earlier articles and is a very worthwhile one to have. It is also important that it can continue beyond one event.

The life insurance trust TSI applies to pre-Budget interest in possession trusts involving life policies where an IIP beneficiary dies and the death gives rise to a change in IIP. The trust will continue to be treated under the pre-Budget rules so that the mainstream trust rules will not apply. The death of an IIP beneficiary will, however, give rise to a chargeable or exempt transfer, depending on who inherits the interest. The transfer will be exempt if the deceased’s spouse or civil partner inherits it.

Let us consider what the life insurance trust TSI looks like. It is found in the new section 49E IHTA 1984 introduced by Para 5, Part 2, Sch 20 FA 2006 and reads like this:”49E. Transitional serial interest: contracts of life insurance.”(1) Where:”(a) A person (C) is beneficially entitled to an interest in possession in settled property (the present interest) and”(b) On C’s becoming beneficially entitled to the present interest, the settled property consisted of, or included, rights under a contract of life insurance entered into before March 22, 2006,

“The present interest so far as subsisting in rights under the contract, or in property comprised in the settlement that directly or indirectly represents rights under the contract, is a transitional serial interest for the purposes of this chapter if the following conditions are met.”(2) Condition 1 is that:”(a) The settlement commenced before March 22, 2006 and”(b) Immediately before March 22, 2006:”(i) The property then comprised in the settlement consisted of, or included, rights under the contract, and”(ii) Those rights were property in which C, or some other person, was beneficially entitled to an interest in poss- ession (the earlier interest).”(3) Condition 2 is that:”(a) The earlier interest came to an end at a time on or after April 6, 2008 (the earlier-interest end-time) on the death of the person beneficially entitled to it and C became beneficially entitled to the present interest:”(i) At the earlier-interest end-time or”(ii) On the coming to an end, on the death of the person beneficially entitled to it, of an interest in possession to which that person became beneficially entitled at the earlier-interest end-time or”(iii) On the coming to an end of the second or last in an unbroken sequence of two or more consecutive interests in possession to the first of which a person became beneficially entitled at the earlier-interest end-time and each of which ended on the death of the person beneficially entitled to it or”(b) C became beneficially entitled to the present interest:”(i) On the coming to an end, on the death of the person entitled to it, of an interest in possession that is a transitional serial interest under section 49C above or”(ii) On the coming to an end of the second or last in an unbroken sequence of two or more consecutive interests in possession, the first of which was a transitional serial interest under section 49C above and each of which ended on the death of the person beneficially entitled to it.”(4) Condition 3 is that rights under the contract were comprised in the settlement throughout the period beginning with March 22, 2006 and ending with C’s becoming beneficially entitled to the present interest.”(5) Condition 4 is that:”(a) Section 71A below does not apply to the property in which the present interest subsists and”(b) The present interest is not a disabled person’s interest.”(2) Sub-paragraph (1) shall be deemed to have come into force on March 22, 2006.”

All pretty complex, eh? Well, not necessarily. The basic principle is pretty straightforward. It is worth saying that there are many many pre-Budget life policies held on IIP trusts and beneficiaries will die under them. In probably the majority of cases, the value of the asset (if it is a protection plan) will be low to nil. Of course, we have those now only too well known issues of:

l A life assured’s ill-health.

l Policy proceeds paid to trustees and be held on trust.

l For non-bare trusts of other than most protection plans, the not-less-than-premiums paid rule.

All or any of these factors could operate to attribute value to a trust and, if there is value, the death of a beneficiary could trigger a charge. If that were the case, then relief from the charge should be welcome.

It is important to note that this life policy-specific TSI relief operates beyond April 5, 2008 and is dependent on the change of beneficiary occurring on the death of an individual with an IIP.

It will not operate where there is any appointment away from a new beneficiary who inherits on the death of a prior beneficiary. There the transfer will be made, typically, by the trustees (or other appointor) electing to use their power of appointment.

This means that the window of opportunity to consider making a single inoffensive appointment of benefits under an IIP trust before April 6, 2008 will continue to be an extremely important one to consider.My husband and I have just inherited £150,000. We have an outstanding mortgage of £99,000, a car loan of £4,000 and no other debt. We have not built up much of a pension fund. I am 37 and he is 47. What should we do with the capital?

First of all, spend some of it. Saving for the future is clearly important but it is also important to get some enjoyment from it today. I am not suggesting you go mad and blow the whole lot but I am sure that whoever left you the money wanted you to get some immediate enjoyment from it. What about that dream holiday you could not quite afford?

The second thing I suggest that you do is pay off the outstanding car loan. You will typically be paying a rate of interest for this loan that greatly exceeds the interest you could earn if you left £4,000 in a bank or building society bank account. Paying off this loan will also free up some of your monthly disposable income.

The third thing I suggest you do is write what will probably be the biggest cheque that you will ever write in your lifetime and pay off your mortgage. I can see a number of benefits to you both in doing this.

There is a non-financial benefit in paying off the mortgage. Just imagine how it must feel. By paying off the mortgage early, you will save a phenomenal amount of interest that would have been paid over the remaining term of the loan. Even if you do not pay off all the outstanding mortgage capital, whatever amount you do pay off will save you a good deal of money.

Some people are reluctant to use up capital to pay off debt. They rationalise this by thinking about how hard it is to create capital and that if they use it to pay off a mortgage, then they are somehow losing it. An alternative might be to consider an offset mortgage where you keep the capital and earn no interest on it but instead pay no interest on your mortgage.

If you pay off part of the mortgage and continue paying the same amount each month to the lender, assuming you have a repayment mortgage, you will at the very least reduce the outstanding loan term.

If you partly or completely pay off your mortgage, you might then apply the savings you make each month as a pension contribution. You could also put the monthly savings from paying off the car loan towards building up a pension fund.

The opposite approach is also worthy of consideration. Instead of paying off the debt, you could simply keep paying it off each month. You then invest the capital you have inherited to build up a pension fund.

Which of the two routes is most likely to produce the best result? I favour paying off the debt and building your retirement funds from regular savings. This allows you to take a greater degree of investment risk with the regular pension contributions. As you buy investments each month, you need worry less about their volatile nature than would be the case if you invested all your capital in one go. In investment terms, the greater the degree of investment risk you take, the greater potential return. Remember, however, that your savings can go down in value as well as up.

As the capital you have inherited exceeds your outstanding debt, you might decide to make a one-off contribution to boost your pension funding. Pension contribution rules these days are much more generous than they used to be, so you should have little difficulty paying almost as much as you want into a pension plan. An added attraction of paying a lump sum as a pension contribution is that income tax relief will be added to your payment. If you invest £1,000 in a pension, the Revenue will add £282.05 to it.

If either you or your husband are higher-rate taxpayers, then it might make sense to apply any one-off contribution to that person’s plan to secure 40 per cent tax relief rather than just 22 per cent.

Ask your financial adviser to calculate how much you need to save each month to create a pension fund big enough to produce a desired level of income at retirement. You may be surprised just how much you both need to set aside to produce a decent retirement income.

If you can save money now by getting rid of debt, then in the long run you stand a good change of building a sizeable retirement fund.

Of course, it is about discipline. You need to save regularly and you must make sure that, having paid off the debt, you do not acquire more in the future.

Nick Bamford is managing director of Informed Choice


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