Writing for Taxation magazine, BKL tax adviser Terry Jordan answers a reader’s query on a ‘second death’ life insurance policy skipping a generation.
My married clients took out a ‘second death’ life insurance policy, which was written in trust for their four children. The policy was taken out in 1998 before the 2006 inheritance tax changes. The trust gave a life interest of 25% to each of the four children, although, due to the nature of the policy, no income has been produced.
All parties (settlors, trustees and beneficiaries) agree that the benefits of the policy, when eventually realised on second death, should ‘skip’ a generation and be paid to the settlors’ grandchildren. It seems that this would, for inheritance tax purposes, constitute a termination of a life interest for the four children and a new settlement would arise. This would mean the rights under the policy would be ‘relevant property’ under the rules applicable since 22 March 2006. I should be grateful for clarification on a couple of points.
First, would four nil rate bands be available, one for each of the original beneficiaries who are, in effect, terminating their life interests? None of them have made other potentially exempt transfers (PETs) or chargeable lifetime transfers (CLTs) in the past seven years.
Second, is anyone experienced in valuing this type of policy? By way of clarification, it is a type that is no longer available from any life assurance provider because, as well as a sum assured on second death, it also allowed for the build-up of an investment surplus. That surplus is now in excess of £1m, and the sum assured £8m. The clients are in their late 50s.
We have discussed the possibility of the original beneficiaries simply passing on the eventual benefits immediately upon receipt. However, for unrelated, non-tax reasons they do not wish to do this.
Readers’ help would be appreciated.
Query 19,203– Ben.
Reply by Terry ‘Lacuna’ Jordan, BKL
The policy value must not be less than the premiums paid
Before Labour’s changes to the inheritance tax trust regime – which were announced on 22 March 2006 with some taking immediate effect – it was common for trusts over life insurance policies to be effected as ‘estate’ interests in possession. It was usual to exclude the operation of Trustee Act 1925, s 31, which would have otherwise permitted the accumulation of income in the case of beneficiaries aged under 18.
If the terms of the trust are now amended in favour of the grandchildren, the four children will be deemed to make immediately chargeable transfers. The value will fall within the relevant property regime because it is too late to create transitional serial interests (IHTA 1984, s 49E not being in point). There will be ten-year charges (counted from the date of the original trust) and a proportionate or exit charge when the funds are distributed. However, a new settlement will not arise.
Four nil rate bands will be available and, if they are exceeded, it is not clear how the trustees’ inheritance tax liability would be funded because there will be no money available until the second death.
So far as valuation is concerned the general principle under IHTA 1984, s 160 is a hypothetical open-market sale. In the case of life policies, IHTA 1984, s 167(1) says:
‘In determining in connection with a transfer of value the value of a policy of insurance on a person’s life or of a contract for an annuity payable on a person’s death, that value shall be taken to be not less than:
- the total of the premiums or other consideration which, at any time before the transfer of value, has been paid under the policy or contract or any policy or contract for which it was directly or indirectly substituted; less
- any sum which, at any time before the transfer of value, has been paid under, or in consideration for the surrender of any right conferred by, the policy or contract or a policy or contract for which it was directly or indirectly substituted.’
So the value must not be less than the premiums paid, although in this case that figure is likely to be less than the current value. It will be necessary to engage an actuary to provide a supportable valuation, especially since the immediately chargeable transfers are likely to be reportable to HMRC when made.
This article is also available on the Taxation website.
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