Continuing on my series of articles looking at the new IHT rules and their effects on insurance base...
Continuing on my series of articles looking at the new IHT rules and their effects on insurance based flexible trusts, this month I examine the position of protection policies in the new regime.
For many individuals with an IHT problem, the easiest and most effective way to deal with it is to insure the liability, providing they are in good health. This is particularly the case for younger individuals who cannot afford to tie up their capital in a discounted gift trust structure, or for those whose main capital asset is the family home.
For an annual outlay, the policy will provide a lump sum to pay the IHT bill, meaning the beneficiaries are not forced to sell the family property. It is a common misconception that insurance is in some way exempt from IHT under UK law. Even HMRC seems confused by this issue, judging by some of the bizarre statements that were contained in its guidance note on the IHT changes earlier this year.
The truth, however, is that insurance proceeds need to be taken out of the insured's estate in order for the proceeds to be exempt. If they are not then the payment on death will just add value to the estate and inflate the IHT liability. The traditional way to do this is to write the policy in a flexible trust for the beneficiaries, and this will continue to be the case in most situations within the new regime.
Of course, under the new regime placing protection policies into flexible trusts will bring them within the "relevant property" regime, which means the payment of the premiums is a chargeable transfer. However, in most instances, one of two possible exemptions will apply. If the premiums are paid out of income and do not materially alter the insured's lifestyle then they should fall within the normal expenditure from income exemption.
If the insured pays the premiums from capital then they can fall within the annual exemption to the extent that they do not exceed £3,000 pa If they exceed this amount then they will be chargeable transfers, unless the nil-rate band is available to offset against them. If it is available then you can pay quite substantial premiums without exceeding the nil-rate band (up to £40,000 pa). Note, however, that this will leave less of the nil-rate band available for any other transfers being contemplated.
For the purposes of the periodic and interim charges, the value of the policy will be the chargeable amount. Policies with no surrender value will, therefore, not usually bear any tax. The only time they may do so is if the insured is terminally ill at the 10th anniversary, as the policy would then have a market value on which to base a charge. Thankfully, individuals are not expected to go for medicals every 10 years to establish their state of health.
Another instance in which a charge could arise is if the policy proceeds pay out just before, and have not been distributed by, the 10th anniversary. The example below illustrates this point:
For protection policies that accrue a surrender value (for example unit-linked whole life), periodic charges will only arise if this exceeds the nil-rate band. In most cases this is unlikely.
However there could be instances where a charge could arise on a policy with a surrender value of less than the nil-rate band. For example, if an individual were to settle a lump-sum gift on flexible trusts up to the nil-rate band, and then he took out a whole life contract a short while later, there could be a problem. This is because the gift into the first trust will eat up the nil-rate band on the second trust, thus pushing the plan value into a charge. Timing of transactions is therefore extremely important in the new regime.
Joined as head of strategy, multi asset, in June
Group income protection
Nine in 10 do not have income protection
Set to become part of Single Financial Guidance Body