Patrick Kennedy, tax and estate planning consultant at Canada Life, looks at the pros and cons of assigning policy benefits for tax purposes
Life assurance policies have many facets and features that can easily be overlooked. Many still prevail, which is amazing given the economic and tax landscape they have travelled through.
The ability to assign policy benefits (linked to trusts or otherwise) is one of their simple, yet powerful, facets. This must be foremost when considering extracting cash from policies in an efficient and tax-beneficial way.
This mechanism is a perfect tool to deflect the tax point from the original owner to a new owner. The benefits of assignment settle on the point that the transaction is not a chargeable event for income tax, provided it is a genuine gift and not being assigned in return for a consideration in money or money’s worth.
When life assurance is a handy tax planning tool
The objective is for the new owner to be a lower or nil rate taxpayer so that ownership rests in their hands. They have the authority (backed by a deed of assignment) to surrender the policy and, being the new owner, pay the tax on the gain, ideally at their lower marginal rate.
There are usually few time constraints on the new owner to surrender the policy, which could play into their hands. Additional years of top slicing relief could accumulate and mitigate the tax consequence on surrender. The timing aspect should focus on the appropriate tax year to surrender. The policy gain can soak up what remains of the new policy owner’s personal allowance, but only for offshore policies.
The assignment strategy works just as well for trustees and is just as tax beneficial. The tax deflection might be greater if trustees can avoid tax at 50% (reducing to 45% from April 2013) in favour of passing it off to the beneficiary at a lower rate.
The point we must not underplay is that an assignment is not a chargeable event for the purposes of income tax (the assignment must not be for money or money’s worth). This is what really drives assignments to be a tax-effective tool.
The main inference has been around the assignee being over 18. It is legally permissible for minors to be party to a contract as well as hold assets. Perhaps a stumbling block is they cannot withdraw from the contract until they attain majority, which does not provide certainty. In Scotland, the same rules apply but the age of majority is 16.
Would your clients really want their ‘little darlings’ to be able to hold and control assets, at an age where they could not cope with them? With some ‘whipper snappers’, they would perish the thought at 18, or beyond! There is legal protection to stop youngsters from financial self-harm; it is called capacity to contract.
Change in practice
Originally, before the recent rule change, the tax treatment of life assurance policies, where the assignment route was used, was not as tax beneficial for minor beneficiaries. HMRC, having taken legal opinion, changed its mind with HMRC Brief 51/2008 (issued on 8 October 2008), effective from 6 April 2007. The longstanding practice of the settlor/trustees being liable for income tax on policy gains was deemed to be incorrect, where it related to bare trusts for minors.
From 6 April 2007, in line with the treatment of income tax for such beneficiaries, they became the taxable entity for life policy gains held in bare trusts. This means potentially better tax mitigation because the bare trust beneficiaries are likely to have ample personal allowance (where it is an offshore policy) to soak up gains, when triggered.
There was little change for parents who set up bare trusts for their children, using life assurance policies, because HMRC did not include the parental settlement rules when it changed its stance. Where the settlor is the parent of the beneficiary (who is a minor and is unmarried and not in a civil partnership) and where chargeable gains exceed £100 in the tax year, all gains will be taxed on the parent.
The position is much better where grandparents or other (wealthy) relatives are the settlor(s) of the bare trust. Then the beneficiary will be the taxable entity when chargeable events are triggered.
Where do discretionary trusts figure in this? With an appropriately drafted deed, trustees can execute a power of appointment (similar to an assignment) to create a bare trust. This carves out trust benefits for minor beneficiaries in the form of specific policies to the required amount, with the underlying asset being a life policy. Tax-efficient school fees planning would be a perfect fit where the dangers of bare trusts can be avoided.
A sign of the times is that changes in HMRC interpretation (Brief 51/2008) can, albeit rarely, deliver tax mitigation opportunities. The outcome deflects tax, by means of assignment. Utilising either the trust mechanism or the plain assignment route should always be uppermost in our minds.
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