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Split heirs

When it a split trust appropriate in business protection?

I am a great fan of paying off debt. Debt is a drag and can prevent you from doing the things you want to do.

By paying off your mortgage, more of your monthly income will be available for you to do as you wish. However, there are advantages and disadvantages.

One way to look at it is to ask yourself how much interest you pay on the outstanding mortgage and how much interest you get on the cash you have. It is likely that your mortgage interest (paid out of taxed income) is greater than the interest you receive from your savings (which is subject to income tax).

To get a greater return on your capital, you may well have to take on board two things – risk and volatility. The risk is that you may end up with less capital than you invested.

Volatility means that the value of your investment can go up and down over time.

Writing out a cheque to pay off the mortgage is a form of investment. You move the money away from getting interest and invest it in the bricks and mortar of your house.

The future value of property can go down as well as up but most people retain a high degree of confidence in the long-term value of property.

When you crunch the numbers, you will probably conclude that paying off the mortgage will save you a lot of future interest payments. On a more subjective note, many people are reluctant to use their hard-earned capital to pay off debt.

Don’t be shy about this. There is, I can tell you, a rather wonderful non-financially quantifiable benefit in paying off a mortgage. Your home will belong to you and you will never have the worry of keeping up the payments.

Keep some of your capital as an emergency fund, just in case. In the future, if and when the Bank of England raises interest rates, instead on bemoaning the fact that your mortgage payments have gone up, you will be able to have a self-satisfied glow of knowing that your savings are paying you more.

You mention that your wife is self-employed and this may mean that your household has variable earnings. You at least now have the certainty of income that your pension brings. By reducing your monthly outgoings by paying off the mortgage, this might also mean reduced financial pressure each month.

You have two choices in respect of your investment-linked endowment. You can keep it going to maturity and carry on paying the premiums.

The maturity value is unknown because it will depend on future investment conditions along with the performance of the provider and the selected investment funds. Alternatively, you might surrender the policy now and enjoy the proceeds as well as saving the cost of future premiums.

As you have retired early due to ill-health, you need to recognise that if you surrender the endowment policy, you will lose the associated life insurance cover and you must consider the impact of that on your family if you were to die.

Your decision may well be based on your attitude towards investment risk and reward and what expectations you have of future investment returns.

In respect of your mortgage and your endowment policy, check the cost of redemption and surrender. There should not be expensive barriers to prevent you from redeeming your mortgage although you may have to pay a fee to the lender. For the endowment policy, there may well be quite severe surrender penalties.

Overall, however, the certainty of paying off the mortgage and saving future costs may be quite compelling.

Nick Bamford is managing director of Informed ChoiceLast week, I looked at the use of split trusts in connection with so-called accelerated death benefit policies used for personal protection.

Assuming that either critical illness or death could trigger a need to buy the critically ill or deceased owner’s shares, the funds on either event should be payable to the continuing owners. A suitable business trust is the usual way to help with this. In a commercial arrangement, there will rarely be any inheritance tax problems.

Of course, if a share purchase does not take place on an owner’s critical illness, say, because he or she is fit enough to return to work, then the funds will need to be held in trust for when a purchase does take place. The trustees of such a trust may need advice on investment, or at least cash management, for the period while funds are held in trust pending purchase.

A sale of shares following critical illness will be a lifetime disposal for capital gains tax purposes but business assets taper relief will be available in many cases to reduce the taxable gain by up to 75 per cent.

Broadly speaking, as well as being a substantially trading business with assets used for the trade, the shares need to have been owned for at least two years to qualify for the maximum 75 per cent reduction. If the disposer’s marginal rate of tax is 40 per cent, then the effective rate of tax on any gain will be 10 per cent.

If the sale takes place following the owner’s death, then the shares will be revalued for capital gains tax purposes and only any gains accruing between date of death and disposal will be assessed to tax.

Where keyperson cover is on the agenda of issues to be discussed, say, in a risk audit of a business client, it is important to consider the financial detriment that can be caused by the critical illness as well as the death of a keyperson.

Where the employer is a company, then the usual method of providing cover will be on a corporately owned/life of another basis. In this case, the rules for the deductibility of premiums and assessability of the sum assured are the same as for ordinary life insurance. This means that where the keyperson is a business owner, there will be no relief on the premiums and no tax on the sum assured. No trust will be needed.

Where the owners decide they would like to keep the proceeds out of the company, then a business trust may be used. Before choosing this route, which will usually only be appropriate where an owner rather than a non-owning employee is the keyperson, the parties will need to carefully weigh the likely greater posttax cost of a trust-based arrangement against the increased flexibility that it can deliver.

The additional cost will be evident if the personal tax and, if appropriate, National Insurance rate exceeds the corporate rate. Tax rates are relevant as the premiums will not be deductible in either case. There is also the usually low risk that not all the beneficiaries following a key owner’s death or critical illness will agree on the use of the funds paid to the trustees. The usual intention will be to make these funds available to the company by way of directors’ loans.

For keyperson cover for partners, a business trust will usually be used to wrap the policy. It may be appropriate to arrange one policy providing a sum sufficient to help with purchase of the business interest and to make sums available for the business to satisfy the keyperson need. The composite sum assured would be paid to the trustees, who would then pay the continuing partners, who would then use the proceeds for partnership share purchase and also to lend back into the business, as partners’ loans, to provide financial compensation for lost profits.

An LLP or a Scottish partnership (as separate legal entities) could effect a keyperson policy and the proceeds would be payable to the business. Policies for the purpose of share purchase cover, however, should be effected on the usual own life/in trust basis even for LLPs and Scottish partnerships.

Split trusts in association with accelerated death benefit policies providing for critical-illness benefits to be paid to the life assured and death benefits to beneficiaries can be highly effective for non-business policies.

However, they will usually be inappropriate for policies to be used in a business context in arrangements between owners as the intended recipients of the critical-illness benefits and the death benefits will be the continuing owners. A non-split business trust will be required here.

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