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Tony Wickenden: Assessing the tax implication of writing protection in trust

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Some providers report that around 90 per cent of all protection policies are not issued under trust. And therein lies a real opportunity for advisers to right what could amount to a very real, and potentially extensive, wrong.

Before we get carried away, it is important to say that a potentially significant proportion of those protection policies not written in trust will have been issued to provide cover for a mortgage and, in most cases, will not have been written in trust for this reason (even though, of course, they could have been).

If they had been written under trust then the new provisions for non-deductible liabilities in relation to IHT would need
to be taken into account.

Where the liability (that is, the mortgage debt) has been repaid by the proceeds of a life insurance policy that had been paid directly into the estate of the life assured, the liability would be discharged if, as is normally the case, the policy has been included in the deceased’s estate.

If the policy is held in trust though and is not in the estate, the deduction would not normally be allowable.

However, there is no reason why the trustees could not refinance the debt so that the estate passes to the beneficiaries encumbered with a new liability.

The process to achieve this would be for the estate to borrow the requisite amount from the policy trustees. The estate would then repay the mortgage so that when the estate is valued the liability will be deductible as the debt will have actually been repaid out of the estate. The beneficiaries under the estate would then inherit the property charged with a new debt owed to the trust under which they are likely to be beneficiaries.

The sum assured under the mortgage protection policy held in trust would, despite the fact that it may be lent to the estate by the policy trustees as just discussed, remain outside of the estate of the deceased.

Leaving aside protection policies written for the purpose of repaying mortgages, there will usually have been a good justification for writing most protection policies in trust; for example to avoid any possibility of IHT and/or to provide for speedy payment without waiting for probate. So why is there such an enormous gap between the number of policies that should be in trust and the number that are?

Well, any protection policy sourced and executed on-line will, perhaps understandably, carry a risk of not being issued subject to trust. That is not to say that trusts are not possible in connection with on-line policies, just that you can easily appreciate how the job might not be finished, so to speak.

Aside from on-line applications for protection policies, another possible reason for the lack of trusts in connection with protection is the lack of awareness of the consequences of the policy not being issued subject to trust or an unwillingness to follow the process because it is too complicated. Another reason is that some may feel that it is unnecessary.

Whatever your thoughts on the reason, the fact offers advisers an opportunity to run a ‘protection audit’ for key clients.

The audit should cover all protection policies that the client holds – and hopefully those not in trust, that should be, were not policies implemented by you!

Once the current (rather than historic) purpose of the cover is ascertained, if a trust (for a non-trust policy) is thought to be appropriate then it will be important to consider the potential IHT implications of making the policy subject to trust. Accessing a suitable trust to “receive” the policy should not be difficult.

Generally speaking, there will only be a value for IHT if there is a surrender value in the policy or if, at the time of the transfer into trust, the life assured is in serious ill health. However, in the case of all policies, other than term policies, it will be necessary to use a value for IHT of not less than the premiums paid to date under the policy.

In most cases, though, even if there is a value to the policy for IHT purposes it may be exempt or fall within the settlor’s nil rate band.

The most obvious outcome for the audit is to identify any policies that should be in trust and convey them into trust.

A fee can be charged unless, of course, you are rectifying your own omission.

In many cases the trust audit will also reveal a serious monetary deficiency in the level of cover and therein lies a real (and mutually beneficial) new business opportunity.

Tony Wickenden is joint managing director of Technical Connection

Access full CPD, technical updates and business generation ideas through Techlink Professional.  Go to www.techlink.co.uk and click the Contact Us link at the top of the screen and then request your free trial from the drop down menu.

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