In his spring budget, Gordon Brown announced big changes to stop people from using Trusts to avoid paying Inheritance Tax. The first thing that happened in the financial and legal worlds was panic and confusion. Ten days after the budget speech, the number of people who could be affected by the new anti-trust laws was estimated to be 4.5 million.
Then, after the draught Finance Bill came out, the number of people was cut to 1 million. So, what's going on, especially with life insurance policies written in trust?
Well, first of all, before we go any further, we need to point out that this article is based on the first draught of the Finance Bill, which won't become law until early July 2006. As I write this, the law has not yet been passed by parliament, so the situation could change again. If it does, I'll let you know about it.
Within a few weeks of the budget speech, the Government changed its mind about how the new law applies to all life insurance policies that are written in trust. As of right now, if your life insurance policy was put into a trust before budget day in 2006, the money in the trust will not be taxed or charged any fees. The law will no longer apply to the past. So there's one less thing to worry about.
But the new tax rules do apply if your policy was written in trust after the Spring Budget Day in 2006.
For most people, the point of putting a life insurance policy in trust is to make sure that the policy pays out quickly and directly to where you want the money to go. This is usually to a mortgage provider to pay off the mortgage or to beneficiaries in the family so they can spend the money right away on whatever they want, tax-free. The new rules do not affect these trusts that end when the person dies. That's because the new rules only apply to trusts that keep money after the policyholder dies.
New life insurance policies written in trust will now be taxed if the payout makes the estate of the person who died worth more than the Inheritance Tax Threshold (IHT) of GBP285,000 and the policy is written in a "interest-in-possession" trust.
Interest-in-possession trusts have been used to hold and invest the money from a life insurance payout and give the income from the trust to the spouse. The money then goes to the children when the spouse dies. After the budget, these arrangements will be subject to a 40% IHT charge when money goes into the trust for your spouse, plus a 6% tax charge every ten years and a "exit fee." You can avoid these taxes if you give your spouse a lot of control over the trust. However, many people may not want to do this, especially if they are in their second marriage and have children from their first marriage. The other option is to use a "bare trust," which is not affected by the new rules. But if you use a bare trust, the money goes to your children automatically when they turn 18.
If you're getting a new life insurance policy and want to use it to pay off your mortgage or give your family money right away if you die, you should still think about putting the policy in trust. But it's more important than ever to buy the policy through a broker who knows everything there is to know about trusts and can make sure you get the type of trust you need.
