We are seeing trusts increasingly become part of the conversation when it comes to protection advice.
Recent research we undertook found eight out of 10 advisers always or frequently discuss trusts when talking to clients about their protection needs. However, the actual number of single life policies in trust across the industry remains low, with only 16.6% written in 2022.
Trusts can be complicated, so, to help explain, here we run through the top five questions advisers are asking.
1. How do policies with critical illness or terminal illness benefits work with a trust?
When setting up a trust, the benefits from a protection policy will either be classed as a ‘retained’ or a ‘gifted’ benefit. The former means whoever is setting up the trust (the donor) can benefit from the proceeds paid out on a successful claim, assuming they are also the life assured. The latter means the donor cannot benefit.
What if the client was diagnosed with a serious illness? This is where nuances between insurers can cause some confusion
A client with a life assurance policy cannot benefit directly given they need to die before a claim can be made. So, it makes sense for them to gift it, which is why life assurance policies are generally considered to be a ‘gifted’ benefit.
But what if the client was diagnosed with a serious illness? This is where nuances between insurers can cause some confusion.
Some life companies treat critical illness, total permanent disability, and terminal illness as a ‘retained’ benefit. After all, if the client is still alive, you would expect that they’d need access to the policy proceeds to fund themselves. But there are some insurers that take a different approach and treat these as ‘gifted’ benefits. So, it’s worth paying close attention to this on the life company’s trust form.
2. Why do discretionary trusts have a default list of beneficiaries?
If you look through a life company’s discretionary trust form, you might come across a clause that refers to ‘discretionary beneficiaries’ to whom the trustees can appoint trust property. There’s a couple of reasons why this exists.
Firstly, under English trust law, a discretionary trust can be in force for up to 125 years to avoid the risk of property being put into trust indefinitely. Having a list of ‘discretionary beneficiaries’ gives provision to the person(s) to access the trust property should the trust reach the 125-year mark – unlikely as this may be, given the property will very likely have been dispensed by this time.
This can be particularly useful where an estate includes a debt such as a mortgage to be repaid
Secondly, from a tax perspective, without this clause there’s a risk the property of the trust reverts back to the estate of the donor and could be subject to the pre-owned asset tax regime.
3. Can trustees make loans from the trust?
Many trusts give trustees the power to make interest-free loans to beneficiaries. These loans need to be repaid to the trust on death. If repaid from the deceased beneficiary’s estate this would be deductible from their estate, thereby reducing the estate value when calculating any inheritance tax (IHT) liability.
This can be particularly useful where an estate includes a debt such as a mortgage to be repaid as, unless that debt is actually paid from the estate, it’s not deductible for IHT purposes.
The lending of the money allows the original debt to be repaid from the estate and is therefore deductible in the IHT calculation, and when the estate is settled the loan is repaid to the trust.
Keeping it in the trust can also protect the money from the creditors of a beneficiary if they are in financial difficulty
At that point, it doesn’t form part of any of the discretionary beneficiaries’ estates so allows time to consider any other planning that may be appropriate. For example, a beneficiary may now have significant wealth and have an IHT issue themselves so don’t want to receive the money and would rather it have passed to the next generation.
Keeping it in the trust can also protect the money from the creditors of a beneficiary if they are in financial difficulty.
4. What happens if there are no surviving trustees on death of the donor?
In a situation where the donor of a trust has died, and there are no surviving trustees. It’s the personal representatives of the last trustee to die who can act as a trustee until they appoint replacements.
It’s important that if all trustees are non-UK resident they seek specialist advice
Bear in mind it’s common for insurers to require two trustees and if a trustee is to benefit, there must be another trustee who is not themselves a beneficiary joining in the appointment of benefits.
5. Can trustees live overseas?
It’s possible for a donor to name overseas trustees, but there are some considerations to bear in mind. Administratively, having overseas trustees can cause delays with any dealings the trustees may need to conduct.
From a tax perspective, if the trustees are all non-UK resident now, or in the future, the trust could be taxed differently. It’s important that if all trustees are non-UK resident that they seek specialist advice.
Gregor Sked is senior protection development and technical manager at Royal London
