Stand Alone Discretionary Life Insurance Trust
Most of us first encounter life insurance when we get a mortgage. It is essential to have a financial vehicle in place to repay the lender should you pass away before the loan has been repaid. Having such an insurance in place prevents the property having to be sold to pay off the debt and prevents all of the associated problems occurring that would otherwise need to be faced by your family through not having such insurance in place such as;
• Being forced to sell the property to repay the loan
• Having the lender foreclose on the loan if repayments were not kept up or the property failed to sell quickly
• Your family having to move, possibly to a new area that’s cheaper
• Your family struggling financially to keep up the repayments
So you decide to look at what the correct insurance product would be for you which could be:
• A whole of life policy that is guaranteed to pay a fixed amount whenever you die. These policies are by nature not cheap because they are covering a known eventuality that will definitely happen. They are therefore best being put in place when you are young so that the premiums are as low as possible. Obviously the older you get the more expensive the premiums becomes as the insurance company have less time to receive payments before your death.
• A level term – this covers you for a fixed period which could be when the mortgage is completely paid off or a specific age where you feel the need for the pay out of a large sum would not be needed any more.
• Decreasing term – this only covers the outstanding balance of the mortgage. Logically therefore they are less and less value for money as time passes as the premiums remain fixed throughout the term. A premium that was once covering an outstanding balance of £200k for example at the beginning of the term will only be covering £1k at the end.
And you think to yourself once you have chosen the product that is right for you – great, I’m sorted. But then you think about who should receive the funds after your death and start to ponder what if…?
• They squander the money as opposed to paying off the mortgage
• Potentially be bankrupt when the money vests in them meaning it would immediately be seized by the Official Receiver
• They are going through a divorce at the time the money vests in them meaning legally their spouse could claim 50% of the funds in a divorce case as the money would legally belong to the individual even though they were only given the money to pay off the mortgage
• They died after receiving the money and before paying off the mortgage meaning the money would be part of their estate and go to their beneficiaries instead of paying off your mortgage
So you discuss your concerns with your IFA and he (sensibly) suggest that the policy you have chosen be put into trust meaning that the funds would not be paid out directly to an individual but would instead be paid to the trustees of the trust with the express instruction that they pay off the mortgage immediately the funds are received thus avoiding all the pitfalls above.
So you’ve decided to get protection, you’ve chosen which protection is right for you and you’ve written it into trust to ensure that it does what it is supposed to - SURELY now you can sit back and relax? Unfortunately not! Because the Finance Act 2013 can catch out the person who has done the sensible thing and put their mortgage protection plan in trust if the way the mortgage is paid off is not actioned correctly.
And here’s why.
The Finance Act 2013 states that the mortgage can only be deducted from the value of the property for inheritance tax purposes if the loan is actually repaid from the estate of the deceased.
As a result, those who have put in place a life policy written in trust, to ensure there is enough to repay the mortgage, would potentially now have an inheritance tax bill if the total value of the estate were above the nil rate band/residential nil rate band (whichever applied) because the policy is not part of the estate if it is written in trust and as such the full value of the property would then be included in calculating their inheritance tax liability.
So be careful – this is what your Executors must be instructed to do.
The executors must borrow the money from the trust to repay the original mortgage and this new loan should then be secured on the property so that the beneficiary receives the property charged with the new debt. In this instance HMRC will then accept that the original mortgage has been repaid from the estate. So, provided the correct steps are followed, it always makes sense to get a life insurance policy to pay off a mortgage placed in trust as the mortgage can still be deducted from the value of the property if the executors proceed correctly. And it should not be forgotten that there are reasons othe r than avoiding inheritance tax to write policies in trust. Even those clients who would not have an inheritance tax liability can benefit because money in a trust is outside of the estate and thus will not be included in the assessment for the new probate fees compulsory from April 2019.
But what if there is a life insurance payout but no mortgage to pay off?
In the case of whole of life policies that are guaranteed to pay out at some point or fixed term policies that could pay out of the insured dies within the term it is quite possible that there may not be any mortgage to pay off.
In these instances we would not recommend an ‘’off the shelf ’’ trust provided by an insurance company. While these trusts are attractive because they are free, they are only designed for holding funds for a short period i.e. from the point the policy pays out up until the point it is used to repay the lender.
Pay outs of potentially £100ks that are not paying off a mortgage should be appointed into a stand-alone discretionary life insurance Trust so the trustees can manage the funds within the trust according to your instructions set out in an expression of trust .
Having a list of potential beneficiaries and reserves makes the trust ‘’discretionary’’ so any beneficiary listed cannot be said to have an ‘’absolute’’ entitlement protecting them from attack through divorce, bankruptcy, future care fees and even protects benefits they might be getting that would otherwise be lost should a direct gift be made.
Stand Alone Critical Illness Trust
If the insurance pay-out is not going to immediately pay off a mortgage then it would be best placed in a stand-alone discretionary trust set up in advance so that the insurance payout can be directed straight into it with the trustees, beneficiaries and wishes already listed. In so doing, any state or other benefits that might be able to be claimed by the policyholder (if it is they who have the critical illness) won’t be affected, withheld or deemed unable to be claimed through having a pile of cash sitting in their account that would otherwise be the case if the pay-out was made directly to them
Stand Alone Discretionary Pension Trust
Pension trusts should ideally be set up in advance ensuring that should you die before taking your pension that the funds in the pension can be instructed in advance to be appointed by the scheme administrators upon your death directly into your trust. This way inheritance tax on that amount of money is avoided because it never goes into your estate or the estate of anyone else. It prevents those funds being at risk should the recipient need to go into care and protects against the future marriage and subsequent divorce or death of all potential beneficiaries. It will also protect against the bankruptcy of any potential beneficiary wiping out those funds should they be left absolutely to them.
Disabled Beneficiary’s Trust
Disabled Beneficiary’s trusts (DBTs) are widely used to protect assets where beneficiaries are suffering from a disability or are otherwise vulnerable. For example, when a person’s chosen beneficiary is in receipt of means-tested benefits, it is essential that a disabled beneficiaries’ Trust is set up before the death of the Testator.
Most often the sums of money involved are not large and, if benefits are lost, will not give any real advantage to the person receiving the inheritance, other than a short break from benefits and a lot of forms to fill in further down the line and in many cases the beneficiary might well be worse off when they inherit because the testator did not put in place the correct trust.
Some people find the support they have been receiving to get their life back on track after a period of severe mental illness, homelessness, addiction, or a combination of these is withdrawn because they will no longer be eligible to receive benefits following an inheritance.
Since the upper capital limit for means-tested benefits, above which a claimant has no entitlement, is £16,000 for a single person or a couple, even reasonably modest inheritances can cause problems.
Some people are not particularly concerned about means testing, but have other reasons for wanting to leave funds to their chosen beneficiary in a Trust. Their relative may suffer from a condition, such as bipolar disorder, that could render them liable to spend excessively at certain stages of the condition; have current or previous addiction issues; be vulnerable to pressure from less-than-well-meaning associates or family members; or might just not be good with money.
The definition of a disabled beneficiary?
A ‘disabled person’ is defined as a person who is:
- by reason of mental disorder within the meaning of the Mental Health Act 1983, incapable of administering their property or managing their affairs;
- in receipt of attendance allowance;
- in receipt of a disability living allowance by virtue of entitlement to the care component at the highest or middle rate;
- in receipt of personal independence payment by virtue of entitlement to the daily living component;
- in receipt of an increased disablement pension;
- in receipt of constant attendance allowance; or
- in receipt of armed forces independence payment.
Where a property is involved and or a significant sum of money it is essential where one of your beneficiaries qualifies as disabled under the above list that you discuss with us the best way of protecting them with the use of a disabled beneficiaries’ Trust after you have gone.
After your death, your gift to your disabled or vulnerable beneficiary is made by your executors directly to the trustees of the DBT whom you have already appointed. They will then look after and distribute these funds according to your expression of trust wishes in a safe and manageable way which will not adversely affect the very person you were trying to help.
Discretionary Gift Trust
These trusts can be used during your life to put funds into up to the Nil Rate band currently £325,000.
If the Settlor survives 7 years, the amount in the trust is no longer deemed to be part of their estate and as such is outside of the scope of inheritance tax upon their death.
Forward planning using these Trusts, where there is an existing inheritance tax liability can, in conjunction with qualified advice from a regulated advisor, save your family many £1000s.
The Settlor of these trusts cannot be a beneficiary but can be a Trustee making these trusts, in many cases, a far better gifting vehicle than purely giving the funds absolutely to the beneficiaries which could then be squandered, lost through divorce, bankruptcy, death, care fees and ultimate inheritance tax on the gift itself in due course by the beneficiary’s own descendents/beneficiaries of their will.
These trusts can also have funds appointed into them after your death from your Will, again, ensuring that the beneficiaries are protected against losing their inheritance going forwards from the same risks.
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