CII R05 Trusts for Life Assurance 2 — Questions and Answers
Question 1: What is the '14-year rule' that is relevant when a life policy is placed in trust?
- A policy must be held in trust for 14 years to obtain IHT relief
- A gift of a policy into a discretionary trust may be subject to IHT lookback over the previous 14 years for cumulation purposes (Correct answer)
- Life assurance proceeds are exempt from IHT if the trust has been in force for 14 years
- Trustees must be replaced every 14 years
Correct answer: A gift of a policy into a discretionary trust may be subject to IHT lookback over the previous 14 years for cumulation purposes
When calculating IHT on a chargeable lifetime transfer (such as placing a policy into a discretionary trust), the previous 14 years of transfers are cumulated against the nil-rate band when working out the tax charge.
Question 2: A married couple take out a joint life second death policy. What type of trust would be most appropriate?
- Bare trust
- Split trust (Correct answer)
- Discretionary trust
- Absolute trust
Correct answer: Split trust
A split trust (also called a flexible trust with split provisions) is ideal for joint life second death policies, as it allows the survivor's rights to be separated from those of the beneficiaries, ensuring the survivor can still access policy benefits during their lifetime.
Question 3: Which of the following is a potential disadvantage of placing a life assurance policy into a discretionary trust?
- The proceeds will be paid more slowly than if not in trust
- The settlor loses control over the distribution of the proceeds (Correct answer)
- The policy can no longer be surrendered
- Premiums become taxable income for the trustees
Correct answer: The settlor loses control over the distribution of the proceeds
Once a policy is placed into a discretionary trust, the settlor loses direct control over how the proceeds are distributed — the trustees have this discretion. This may be a concern if relationships with trustees break down.
Question 4: What is a 'letter of wishes' in the context of a life assurance discretionary trust?
- A legally binding instruction to the trustees on how to distribute the trust fund
- A non-binding document from the settlor expressing their preferences to the trustees (Correct answer)
- A formal court order overriding the trust deed
- A notice to the insurer to change the beneficiaries
Correct answer: A non-binding document from the settlor expressing their preferences to the trustees
A letter of wishes is a non-binding document that expresses the settlor's preferences regarding trust distribution. Trustees are not legally obliged to follow it but will usually take it into account when exercising their discretion.
Question 5: A policyholder places a whole of life policy into a discretionary trust. The policy has a surrender value of £400,000. What is the potential IHT implication?
- No IHT implications arise when placing any policy in trust
- The transfer may be a chargeable lifetime transfer, with an immediate 20% IHT charge on the value above the nil-rate band (Correct answer)
- The transfer is an exempt transfer regardless of value
- IHT is only triggered if the settlor dies within three years
Correct answer: The transfer may be a chargeable lifetime transfer, with an immediate 20% IHT charge on the value above the nil-rate band
Placing a policy with a significant surrender value into a discretionary trust is a chargeable lifetime transfer for IHT purposes. If the value exceeds the available nil-rate band (£325,000), an immediate IHT charge of 20% applies.
Question 6: In the context of life assurance trusts, what is the 'reservation of benefit' rule?
- Trustees must reserve 10% of the proceeds for the settlor
- If the settlor retains a benefit from the trust property, the gift is ineffective for IHT and the assets remain in the estate (Correct answer)
- The insurer reserves the right to contest the trust arrangement
- Beneficiaries must be at least 18 to benefit from the trust
Correct answer: If the settlor retains a benefit from the trust property, the gift is ineffective for IHT and the assets remain in the estate
Gift with reservation of benefit rules mean that if the settlor retains any benefit from assets placed in trust (e.g., could still benefit from a life policy), HMRC treats the assets as still in the estate for IHT purposes.
CII R05 Trusts for Life Assurance 2
What is the '14-year rule' that is relevant when a life policy is placed in trust?