Most life companies allow their bonds to be split into a number of 'mini policies', known as segment...
Most life companies allow their bonds to be split into a number of 'mini policies', known as segments or clusters. Each segment is a policy in its own right and is designed to add flexibility to the plan.
One of the benefits and frequent uses of policy segmentation is when a partial surrender is taken from the bond. A withdrawal of up to 5% of the original investment can be taken each year for 20 years without an immediate liability to income tax. If the 5% is not taken in any policy year the unused allowance can be carried forward on a cumulative basis. Any excess over and above the 5% allowance is chargeable excess, which will be liable to tax at the policyholder's marginal rate. The calculation to determine chargeable excesses ignores any growth in the bond.
Policies in Trust
When a chargeable event occurs and a policy is in trust, any tax liability will fall to the creator of the trust (the settlor) up to a maximum rate of 40%. If the settlor is dead or non-UK resident the liability will fall to the trustees (providing at least one of them is UK resident) at the trustee rate of 40%.
A simple way of passing the trust property (the proceeds of the investment bond) to a beneficiary is by assignment. Assigning a policy absolutely to a third party is not a chargeable event for tax purposes as long as the assignment is done by way of a gift. Once the policy has been assigned, the assignee, as the legal owner of the policy, can surrender the policy, providing of course that the assignee is over 18. If the beneficiary is a basic-rate or non-taxpayer, this is a simple way of passing on the benefits to the beneficiary in a tax-effective manner.
How many segments?
Most flexible trusts are designed to pass the trust property to a number of potential beneficiaries. This being the case, where the trust property is an investment bond then segmentation is invaluable as a means of splitting the benefits (whole policies) between beneficiaries.
Giving some thought at the start of the plan on how many segments to choose may save potential trustees some administrative hassle at a later date. For example, where there are three established beneficiaries, choosing a number divisible by three - say, 90 rather than the default 100 - may help the trustees to dispose of the trust property where the benefits are to be paid in equal parts. But, as is often the case, what if the number of beneficiaries is not known or, as is more likely, the policy is issued and the trust is added at a later date? Simply choose a number of segments at the outset that will give future trustees an element of flexibility. Take, for example, the number 60. This number of segments can be split equally between two, three, four, five or six potential beneficiaries, rather than a default of 100 segments, which limits the choice to two, four and five.
Family tax planning
Finally, where the policyholder is a higher-rate taxpayer, assigning individual segments to a non-taxpaying (or lower-rate taxpaying) spouse or adult child is a tax-effective way of passing capital on between family members.
- Peter Ashton is a technical consultant at Friends Provident International.
To aid regulatory reporting
Three year strategic review
Impact on markets
Has run Cautious Managed fund since 2011
What’s right – not what sells