Succession Planning Bond Trust Guide Contents

Succession Planning Bond Trust Guide contents

Introduction ...... 3

Inheritance Tax ...... 4

Domicile ...... 6

Reducing the effect of IHT �� 8

Transferring assets/Gifting �� 8

Insuring the liability ...... 10

IHT planning using trusts �� 12

Trust planning decision tree �� 15

The Discretionary Gift Trust �� 16

The Discretionary Loan Trust ��18

The Discretionary Capital Access Trust ��20

The Discretionary Discounted Gift Trust �� 22

Wills & Intestacy ...... 24

Glossary of Terms ...... 26

2 introduction

The aim of this guide is to give a brief outline of UK inheritance tax (IHT), and to highlight some of the opportunities available for inheritance tax planning using Friends Provident International’s Succession Planning Bond. The information applies to individuals who are UK-domiciled for IHT purposes, and to individuals who are non-UK domiciled, but UK resident.

This guide and the information contained within it should only be used in consultation with a Financial Adviser.

All Discretionary Trusts will be treated as a “relevant property” settlement. The following is our understanding of the tax consequences of creating a relevant property settlement:

• The initial gift is a chargeable lifetime transfer (CLT) subject to inheritance tax at 20% to the extent that it, together with other CLTs made by the same Settlor in the seven years before creating the Trust, exceeds the current nil rate band. The gift will be the value of the policy that is gifted into trust less the value of the Settlor’s entitlement under the trust.

• There is a potential liability on the trust to inheritance tax on every 10th anniversary. This is known as the “periodic charge”. At a maximum this will be 6% of the value of the trust fund but will frequently be much less than this.

• There is a potential liability to inheritance tax when capital leaves the trust (an “exit charge”) which will be linked to the rate of IHT paid at the last ten year anniversary or, if the capital leaves the trust in the first 10 years, when the trust was created. Payments made to the Settlor in respect of his entitlement under the trust will not be subject to the exit charge.

HMRC Reporting It is currently a legal requirement for any chargeable lifetime transfers that comprise of cash and cause the Settlor to exceed his/her nil rate band to be reported to HM Revenue & Customs (HMRC) on Revenue forms IHT 100, IHT100a and D34. These forms are available on the HMRC website at www.hmrc.gov.uk/cto/forms12.htm

The occasion of a periodic charge or exit charge also needs to be reported even if no IHT liability arises unless the cumulative total of the assumed transferor does not exceed 80% of the then nil rate band. The forms to use here, when relevant, are IHT 100c and d, and form D34.

This information is correct as of December 2012.

3 inheritance tax

Inheritance tax has its origins as far back as the Roman Empire. Caesar Augustus introduced an inheritance tax to provide retirement funds for the military.The tax was 5% on all inheritances except gifts to children and spouses.

Inheritance tax (IHT) in the UK is both a cumulative tax on death, and on certain transfers (gifts) made during a person’s lifetime.The first £325,000 (2012/13)* the ‘nil rate band’ (NRB) is free of IHT.

Every individual has a NRB, which until recently could be lost on death if transfers were made between spouses or civil partners (CP). Following the Chancellor’s pre-Budget statement on 9th October 2007, any part of the NRB which is not used on the death of the first spouse (CP) can now be carried forward and used by the surviving spouse (CP) on their death.

Chargeable lifetime transfers over the NRB are taxed at 20% and on the total value of an individual’s estate on death at 40%. The total estate on death is the value of the UK-domiciled individual’s combined assets, wherever in the world these assets are situated, and include real property, investments and personal effects.

* The current NRB was set in 2009/10 and has been frozen for five years to 2014/15 Example 1 The example shows how the value of a person’s estate can be significantly reduced by inheritance tax.

4 the effect of inheritance tax

Mrs White is a widow with three children. Her husband left his estate completely to her on his death. When Mrs White dies, her estate on death includes:

House 900,000 Investment property 300,000 Investments 333,333 Deposits 100,000 Personal effects 100,000

Total Estate 1,733,333

Less nil rate bands 2 x 325,000 (650,000) † Estate for IHT 1,083,333 Tax 1,083,333 x 40% = 433,333 Estate 1,733,333 – 433,333 = 1,300,000

Estate £1,733,333

Beneficiary Beneficiary Beneficiary HMRC £433,333 £433,333 £433,333 £433,333

† Mrs White’s current NRB plus Mr White’s unused NRB example

5 domicile

An individual’s liability to UK inheritance tax is primarily governed by their domicile at the time a transfer of value takes place. A person domiciled in the UK is liable to inheritance tax on the total value of his or her assets wherever in the world these are situated.

The basic concept of domicile is that a person is domiciled in the country that he or she regards as their real home. Domicile is normally acquired through birth, through parents or through long-term residence.

The UK concept of domicile goes beyond a mere physical presence in the UK, which means UK-domiciled individuals could find that their worldwide assets are subject to UK inheritance tax even though they are not physically resident in the UK at the time.

The main categories of domicile: • Domicile of origin • Domicile of dependency • Domicile of choice • Deemed domicile

6 Domicile of origin Under English law, an individual acquires at birth the domicile of the person on whom he or she is legally dependent, which the individual retains until reaching the age of 16.

Domicile of dependency If the domicile of the person on whom an individual under the age of 16 is legally dependent changes, he or she will acquire the new domicile automatically, which will be retained until the age of 16.

Domicile of choice On reaching the age of 16, a person has the legal capacity to acquire a new domicile of choice. To acquire a new domicile of choice, the individual must leave the country of his or her current domicile and settle permanently in the new domicile of choice. A change of domicile to a new domicile of choice requires strong evidence (in addition to just living there) that the change of domicile is permanent.

Deemed domicile For inheritance tax purposes, there is a concept of ‘deemed domicile’. This means that, even if the individual was not at the time domiciled in the UK, he or she will be treated as domiciled in the UK if, at the time a transfer of value was made:

• he or she was domiciled in the UK within three years immediately prior to the transfer, or

• he or she was resident in the UK in at least 17 of the 20 income tax years ending with the year in which the transfer was made.

7 reducing the effect of iht

According to HMRC, the number of families caught by IHT has more than doubled over the last 10 years. Despite this, only a small percentage of the population actually paid this tax. This is because there are a number of simple and effective ways of reducing the tax. As well as using available reliefs, careful planning can in most cases avoid the tax completely and preserve the value of the estate for the chosen beneficiaries.

Transferring assets/Gifting

Transfer of value A transfer of value is a disposition made by a transferor, whereby the value of the estate immediately after the disposition is less than it would have been had the disposition not been made. This is often referred to as the ‘loss to donor’ principle, and is one of the basic principles of IHT.

Chargeable transfers A chargeable transfer is a transfer of value made by an individual, which is not an exempt transfer.

Exempt Transfers There are a number of transfers (gifts) that are normally exempt from IHT:

• Transfers between Spouses (Civil Partners) – are exempt from IHT if both spouses (CP) are UK-domiciled. Where a transfer of value is from a UK-domiciled spouse to a non-UK domiciled spouse, then the exempt transfer is limited to £55,000.

• Annual Exemptions – each individual can transfer an exempt amount of up to £3,000 per year. Any unused amount can be carried forward for one year only.

• Small gift exemption – up to £250 per person in each tax year. • Normal expenditure out of income exemption – unlimited amounts can be transferred free of IHT provided the following conditions are met: – The transfers are regular in nature and come from the donor’s income – The donor’s standard of living is not reduced as a result of the transfers. • Gifts on marriage (CP) – gifts in consideration of marriage (CP) are exempt transfers up to a maximum of £5,000 if given by each parent, £2,500 by each grandparent, £2,500 by the bride and groom (CP) to each other, or £1,000 by anyone else.

• Gifts to charities and political parties – are exempt transfers with no limit. • Gifts for the national benefit – are exempt transfers with no limit.

This information is correct as of December 2012.

8 Potentially Exempt Transfers (PET) These are transfers of value made between one individual and another individual, to a bare trust or to a trust for a disabled person. To be totally effective for IHT purposes the transferor must survive a period of seven years from the date of the transfer.

If the death of the transferor occurs within seven years of the PET, the amount of the transfer will be deducted from the individual’s NRB.

Where the transfer exceeds the NRB, then the excess will be added back into the estate as a chargeable transfer.

Taper relief may reduce the amount of tax payable depending on when within the seven years the transferor dies – see the table below.

Years before death in Percentage of tax Effective rate which transfer was made payable on transfer of tax 1 – 3 100% 40%

3 – 4 80% 32%

4 – 5 60% 24%

5 – 6 40% 16%

6 – 7 20% 8%

9 reducing the effect of iht (continued)

Gifts with reservation Property that has been transferred (gifted) may still form part of the transferor’s estate for IHT purposes, if the transferor reserves the right to enjoy or benefit from the gifted property (see Example 2 opposite).

Insuring the liability

Whole of life assurance Covering the IHT liability with a life assurance policy is an affective alternative to transferring (gifting) assets, providing, of course, that the policyholders are in good health and still young enough to make the premiums affordable.

The policy is normally written as a whole of life last survivor policy, and held in trust for the beneficiaries. The proceeds are paid on the death of the last of the lives assured to die, Example 2 and then used by the beneficiaries to pay the inheritance Gifts with reservation tax. One or more of the exemptions could avoid the premiums being charged as lifetime transfers.

Term assurance It is a common tax planning exercise when effecting a PET for the transferor to effect a seven-year decreasing term assurance policy at the same time. The policy sum assured covers the outstanding IHT liability should the transferor die within the seven-year period. The sum assured decreases in line with the taper relief, and has no value after seven years.

10 reducing the effect of inheritance tax

Example 2 Tom Adams has a large estate made up of his main residence and a collection of paintings. He is aware that his estate will attract a large IHT bill when he dies.

He decides to reduce the value of his estate by giving his son one of his valuable paintings. This he does, and on doing so, asks his son as a favour, to leave the painting on his study wall.

This is a gift with reservation as Tom can still enjoy the painting even though he has given the painting to his son. On this basis the painting will remain part of Tom’s estate for IHT purposes. example

11 iht planning using trusts

Transferring an asset (such as an offshore investment bond) into trust will change the legal ownership of that asset. This invariably changes the taxation of the asset, which creates a number of important tax-planning opportunities for the adviser to consider.

One of the most effective uses of trusts is inheritance tax mitigation. Friends Provident International (FPI) offers a number of trust structures that have been designed to reduce the exposure to Inheritance tax. A number of these structures allow the creator of the trust to have access to all, or a proportion of, the trust capital. All of our IHT plans combine a trust with an offshore bond.

The decision tree on page 15 summarises FPI’s trust range and acts as a simple guide on when to use which trust.

A trust can be used to preserve wealth for future generations. By placing assets in trust, the creator of the trust (the settlor) can provide a degree of financial security for the immediate family and beyond. A suitable trust can give parents and grandparents peace of mind as regards the well-being of future generations.

A trust allows the settlor to determine (through the trust deed) how the trust assets should be distributed in the future. This is especially useful where the beneficiaries are minors as it allows the trustees to determine when and to whom the benefits will be paid.

12 Why use an offshore investment bond?

As a trust asset, an offshore investment bond can provide significant tax and administrative benefits. FPI is a tax exempt insurance company based in the Isle of Man. We do not pay any income tax, capital gains tax nor corporation tax in respect of the policyholders’ funds. With the exception of certain withholding taxes which may be deducted at source on dividend payments, once invested, the investment capital can accumulate entirely free of tax

Offshore investment bonds are non-income producing assets. Therefore, in the hands of UK resident trustees they do not generate an ongoing income tax or capital gains tax charge. A tax charge only arises when benefits are taken. An offshore bond is a trustee‑friendly asset as it relieves many of the accounting and administrative burdens of the trustees.

The tax charge for offshore investment bonds written under trust will usually fall on the settlor of the trust. This in itself may present a number of opportunities, for example the settlor may be a non-tax payer as a result of being resident outside of the UK.

Where the settlor is deceased or non-resident the tax charge will fall on the trustees. If the trustees are outside of the UK, then the tax charge will fall on UK beneficiaries, but only when they receive benefits.

Benefits can be extracted tax efficiently by utilising the 5% withdrawal allowance and by assigning individual policies to beneficiaries to encash. For more details please contact your financial adviser.

13 iht planning using trusts (continued)

Bare trust or discretionary trust

A bare trust, or absolute trust, is one in which each beneficiary has the absolute right to the trust capital and income. The beneficiaries of a bare trust have the right to take possession of the trust property on reaching the age of 18 (England and Wales).

The creation of a bare trust is a Potentially Exempt Transfer (PET) and therefore not subject to the ‘relevant property’ regime. Any tax on the income of the trust is charged to the beneficiaries if they are over 18 and the assets form part of the beneficiaries’ estate for IHT.

A discretionary trust, or flexible trust, is subject to the ‘relevant property’ regime. The gift into trust is a ‘chargeable lifetime transfer’ chargeable at a rate of 20% over and above the Nil Rate Band (NRB).

There is also a 10 year periodic charge of 6% (over the then NRB) and an exit charge when capital leaves the trust.

Which trust?

The choice of trust will depend on the individual’s financial and family circumstances.

An absolute trust will be useful where the settlor needs to make large gifts (over the NRB) to reduce inheritance tax and where the donor is confident that he/she will not need to change the beneficiaries.

The drawback is that the beneficiaries cannot be changed and can demand the trust property at age 18.

A discretionary trust will be useful where the settlor wants the control over who will benefit and when, which may include the settlor.

The drawback is that the discretionary trust is subject to the relevant property regime. FPI’s range of trusts However, a discretionary trust may be worth considering where the value • The Gift Trust of the transfer will not exceed the nil rate band, or is within the available exemptions. • The Loan Trust • The Capital Access Trust Furthermore, where the only asset is an FPI insurance contract and the settlor is non-UK domiciled, the UK relevant property regime will not apply. • The Discounted Gift Trust

14 trust planning decision tree

Are you willing to give up total access to the capital invested?

YES NO

Do you wish to retain the ability Are you willing to give up access to change beneficiaries? to a portion of the capital invested?

YES NO YES NO

Consider the Consider the Do you wish to Do you wish to have all the capital Discretionary Absolute retain the ability outside of your estate after 7 years? Gift Trust Gift Trust to change beneficiaries?

YES NO YES NO

Do you wish to Do you wish to Consider the Consider the retain the ability retain the ability Discretionary Absolute to change to change Capital Access Capital Access beneficiaries? beneficiaries? Trust Trust

YES NO YES NO

Consider the Consider the Consider the Consider the Discretionary Absolute Discretionary Absolute Discounted Discounted Loan Trust Loan Trust Gift Trust Gift Trust

15 the discretionary gift trust

The Discretionary Gift Trust

Gifting assets to reduce the value of an estate is still the simplest and most effective form of inheritance tax planning. Transferring assets into a Discretionary Gift Trust enables the settlor(s) to transfer assets from their estate, the value of which, will be outside of the estate for IHT purposes, providing the settlor survives seven years from the date of the transfer. Any growth in the value of the transfer is also outside of the estate.

Whilst the trust contains a wide class of beneficiaries, the settlor(s) are not beneficiaries so as to avoid the Gift with Reservation rules. The settlor(s) can, however, be trustees.

The Discretionary Gift Trust is useful for individuals who have used all of their IHT exemptions, but still have a large IHT liability. Providing the settlor is happy to give away assets, and give up access to those assets, the Discretionary Gift Trust will remove the capital from his estate, but will allow them to control its distribution.

Summary of benefits • The ability to make gifts potentially free of IHT • Control over who will receive benefits and when • Flexibility to add or remove beneficiaries at any time • Investment growth free of IHT.

16 the discretionary gift trust in action

Doris Knight’s two children are becoming more and more concerned about the potential inheritance tax on their inheritance. Doris, who is 71, inherited the house and a number of large deposits from her husband John some three years ago — a total estate of £2 million. Fortunately, at the time, no IHT was payable when John died because of the gifts between spouses exemption.

Doris’s Financial Adviser has given her a breakdown showing the extent of the inheritance tax liability, which comes as quite a shock. The Financial Adviser also suggests a number of possible solutions. The good news is that John’s unused nil rate band can now be carried forward for Doris to use, which will certainly ease the problem.

Unfortunately, Doris has a slight health problem, which means that the cost of insuring the IHT liability at her age is prohibitive. Fortunately, Doris is quite comfortably off. She has far more income than she needs, which means she could reduce her estate considerably without it affecting her normal standard of living.

The Financial Adviser suggests that she uses some of the IHT exemptions, in particular her unused annual allowances, and make some transfers to her grandchildren using the gifts out of income exemption. He also recommends that she reduce the IHT liability over the next seven years by investing some of her capital into an FPI offshore investment bond, and gift the bond into a Discretionary Gift Trust – which she does. She keeps the gift within her nil rate band to avoid the charge to lifetime IHT.

Doris is the settlor of the trust and also a trustee. She appoints her two children as trustees and writes the bond on the lives of her four grandchildren. The immediate beneficiaries are her children and the discretionary beneficiaries include her grandchildren. Doris is not a beneficiary as this would be a gift with reservation, and would not work for IHT planning. If, as is expected, Doris survives seven years, the value of the Discretionary Gift Trust will be outside of her estate and free from IHT. example

17 the discretionary loan trust

The Discretionary Loan Trust

Loan trusts are suitable for individuals who need to do some IHT planning but are not prepared to give capital away. The creation of a Discretionary Loan Trust is not a gift for IHT purposes so is not a chargeable lifetime transfer. However, the 10-year periodic charge could apply if the investment growth is in excess of the then NRB

How it works The plan involves the settlor creating a flexible trust for the benefit of specified ‘named beneficiaries’, with the power to appoint benefits to a wide class of potential beneficiaries. The trust is created with a lump sum, which is provided in the form of an interest free loan to the trustees, which is repayable on demand. The trustees then invest the capital in an FPI offshore investment bond.

The settlor will have access to the capital in the form of loan repayments by the trustees. If the loan repayments Summary of benefits are kept within the 5% per annum withdrawal allowance, Only the value of the outstanding loan the payments will not be taxable on the settlor at the • forms part of the settlor’s estate – time they are taken. As each loan repayment is taken and ‘estate freezing’ spent, the value of the settlor’s estate gradually reduces. Any outstanding loan amounts remain part of the settlor’s • All growth on the capital is immediately estate for IHT purposes. Any growth in value of the outside the settlor’s estate offshore investment bond is held for the benefit of the • The settlor has access to the whole of beneficiaries and is free of IHT. his original capital • The settlor has access to payments on a regular or irregular basis • The settlor can nominate specific beneficiaries • The settlor retains influence over destination and timing of benefits.

18 the discretionary loan trust in action

Pete Brown is 48 years old, and married with two adult children. He is a senior investment analyst with a leading fund management group. A keen investor himself, he is well aware of the benefits and tax-efficiency of an offshore bond wrapper. He has been dealing with a local Financial Adviser and has agreed to invest into an FPI offshore investment bond using his firm’s discretionary management service.

Following the fact find, the Financial Adviser advises Pete and his wife to start thinking about the effects of inheritance tax. Their jointly-owned property and current assets are already in excess of their nil rate bands. So the liability is likely to increase over time.

They discuss a number of options, including estate reduction. At this stage, Pete is not prepared to give assets away to reduce IHT. He still wants access to the capital. But he does agree that gifting capital could be an option for the future. As an alternative, the Financial Adviser suggests they look at the cost of insuring the present IHT liability, and consider ways of reducing the effects of IHT in the future. The Financial Adviser explains the merits of setting up a Discretionary Loan Trust along side the FPI investment.

Setting up a Discretionary Loan Trust is not a gift for IHT purposes and therefore not a chargeable lifetime transfer. The loan that Pete makes to the trustees will be interest-free and repayable as and when Pete decides. Whilst the outstanding loan stays within the estate for IHT purposes, any growth in the investment over and above the initial loan is for the beneficiaries, and immediately outside of the estate. In addition, if Pete takes the loan repayments to spend as income, this will also have the effect of reducing the estate.

Pete sets up the FPI Discretionary Loan Trust appointing himself, his wife and two children as trustees. He also appoints the children as named beneficiaries. The trustees use the loan to invest in the FPI offshore investment bond. Pete instructs the trustees to repay the loan using the offshore investment bond’s 5% per annum tax-deferred allowance. Pete can if he wishes stop the loan repayments. He might also decide in the future to forgo the outstanding loan and gift the capital on to his beneficiaries. The gift will then be outside of Pete’s estate after seven years. example

19 the discretionary capital access trust

The Discretionary Capital Access Trust

It is often the case when discussing inheritance tax planning that the individual, whilst happy to give away certain amounts of capital, is not willing to give up access to the income that is generated from the capital. On the other hand, it might be that income is not an issue, but they want to retain a portion of the capital for that rainy day emergency to cater for the unexpected. If either of these scenarios is an issue then the Discretionary Capital Access Trust may be the solution.

How it works The investor establishes a flexible power of appointment trust where the trustees hold property on a specified trust, which comprises two parts:

The settlor’s capital entitlement The settlor declares an amount of money that he wishes to be held for his absolute benefit under the trust. This can Summary of benefits be any figure between 10% and 90% of the original capital • All investment growth is immediately investment and is expressed as a fixed capital sum rather outside the settlor’s estate than a percentage. The amount retained will depend on The gifted part is completely outside the settlor’s likely future requirements. • the estate after seven years The settlor can then: • Access to the retained part may be • take regular capital payments from the taken as regular or irregular payments entitlement • 5% withdrawal entitlement based on • take ad-hoc payments of capital the whole capital amount • Flexibility to make further gifts from • leave as an emergency fund the retained part • revoke part or all of the entitlement if • Ability to control who receives benefits subsequently the retained capital is not required. and when they receive them Any amounts not taken and spent or gifted will form part • The trust fund will not form part of the of the settlor’s estate for IHT. beneficiaries’ estate for IHT.

The beneficiaries’ fund This part of the trust fund is held for the named beneficiaries, normally the settlor’s children or grandchildren or for any of the Potential Beneficiaries, which may also include the settlor’s spouse. The settlor cannot benefit from this part of the trust, which means the transfer is a chargeable lifetime transfer for IHT purposes.

20 the discretionary capital access trust in action

Henry, who is 53, has been an actor for a number of years. He is married with one daughter who is at university. He lives in a four-bedroom period cottage in the New Forest.

His Financial Adviser has presented an inheritance tax report and suggested a number of ways of reducing his estate immediately using IHT exemptions. Over the longer-term the Financial Adviser has suggested a reduction of the estate by taking advantage of the seven-year gift period.

However, at this stage Henry is reluctant to part with all of his capital. But he is prepared to gift some of his assets away bearing in mind the main beneficiary of his estate will be his daughter. The Financial Adviser asks Henry to consider the Discretionary Capital Access Trust.

The benefit of the Discretionary Capital Access Trust for Henry is that he can decide what percentage of the trust capital he wants to gift away and the percentage he wants to retain for his own use. The gifted portion of the trust is a chargeable lifetime transfer, and it will be outside of his estate after seven years. It is also a flexible trust for the benefit of his daughter and other discretionary beneficiaries. Henry is advised to keep the gifted portion to below his nil rate band (and annual allowance) to avoid the IHT lifetime charge.

The retained portion of the trust is a bare trust for Henry’s own benefit. He can, if he wishes, draw down and spend the capital using the tax-deferred withdrawals from the FPI offshore investment bond. What’s more, he can take up to 5% per year of the original investment for the number of years the retained portion reflects. For example, if Henry retains 50% of the investment, he can withdraw 5% per year of the original investment for 10 years (i.e. 10% per year of his retained portion).

Another benefit for Henry is the flexibility to gift the retained capital onto the beneficiaries over a number of years. This can be done tax-effectively using the annual exemption and his new nil rate band after seven years. example

21 the discretionary discounted gift trust

The Discretionary Discounted Gift Trust

Transferring assets into a Discretionary Discounted Gift Trust (DDGT) enables the settlor(s) to reduce the value of their estates for inheritance tax purposes, and still have access to the assets by way of regular capital payments. The trust is suitable for individuals who have a liability to IHT and are happy to make substantial gifts, but need access to regular payments to maintain their standard of living.

How it works The settlor(s) effect an FPI offshore investment bond, and set up the right to receive annual capital payments up to Summary of benefits 5% per annum of the original capital. The policy is then • Immediate reduction in the settlor’s assigned into trust, which is split into two parts — the estate by way of a discount for IHT settlor’s fund, and the beneficiaries’ fund. The settlor’s purposes fund provides that, should they be alive on each trust • The trust enables the settlor to make anniversary, they will receive a capital payment, chosen a substantial gift and the beneficiaries at outset by them and expressed as a percentage of the to enjoy tax free growth on the original investment. The settlor(s) will be entitled to capital investment payments whilst they are alive. • The settlor has the right to receive The value of the beneficiaries’ fund, together with any fixed regular cash payments during growth, will fall outside of the settlors’ estate after his lifetime or until the death of the seven years. surviving settlor if joint settlors • The option to have husband and wife Discounted Value as joint settlors (assuming both are Carving out the contingent rights to capital payments in UK-domiciled) this way gives an immediate reduction in the settlor’s • The trust can be used with any FPI estate by way of a discount on the value of the gift for IHT product. This enables the trustees to purposes. This means that there is an immediate reduction defer tax until a chargeable event is in the IHT liability should the settlor die within seven years created. of creating the trust.

22 the discretionary discounted gift trust in action

Divorcee Jane Critchley, 76, has lived in the same house for over 30 years. She has seen her property rocket in value over the last 10 years. The house, together with her investments, means that she is now well into the inheritance tax bracket.

During a consultation with her Financial Adviser, she explains her reluctance to give up the access to capital. Whilst she agrees with the Financial Adviser that she needs to make gifts of capital to reduce her estate over the next seven years, she is reluctant to do so if it lowers her standard of living. The Financial Adviser explains to her the benefits of a discounted gift trust.

Jane creates an FPI Discretionary Discounted Gift Trust, carving out a contingent interest of up to 5% per annum from the offshore investment bond. Jane, as the settlor of the trust, is automatically a trustee.

The contingent interest gives Jane a regular payment each year of up to 5% of the original investment for as long as she lives. Should she die within the first seven years, the value of the gift will be discounted, which will reduce the amount of IHT paid. The amount of discount is determined by her age and state of health at the time that she creates the trust. After seven years, the initial gift will be outside of her estate for IHT purposes. Any growth in the investment is outside of her estate immediately. example

23 wills & intestacy

Reasons for making a will

It is very important for everyone to make a valid will and to review it regularly, especially where personal circumstances change, such as getting married (CP), getting divorced, or having children or grandchildren. Failure to make a will means that an individual would die intestate, which means that the estate would be distributed in accordance with the “rules of intestacy”. This could result in the estate not being distributed in accordance with the deceased’s wishes.

In addition to avoiding the rules of intestacy, there are a number of personal reasons why an individual would want to make a will, and could include the following:

• to distribute their assets and personal effects in accordance with their wishes • to make provision for their children regarding guardianship and how they will be provided for

• to indicate their funeral requirements • to help reduce death duties • to make provision for their pets • to leave money to their favourite charity • make provision for the nil rate band:

– to leave all to the spouse (CP), or

– controlled distribution with a trust.

24 Intestacy

A person who dies without leaving a valid will is said to have died intestate. In this case, the estate of the deceased is distributed in accordance with the law of intestacy, which means that the distribution of the deceased’s assets will depend on whether there is a surviving spouse (CP), whether there are children or grandchildren, or whether there are other blood relatives of the deceased. In England and Wales, the estate of a person dying intestate will pass as follows:

• A surviving spouse (CP) and children The surviving spouse (CP) will receive the deceased’s personal belongings and a statutory legacy of £250,000. The spouse (CP) will also receive a life interest in half of the remaining estate.

The children receive half of the residual estate in equal shares when they reach the age of 18, and the other half of the estate on the death of the surviving spouse.

If any of the children have died then their children will receive their parents’ share (per stirpes).

• A surviving spouse (CP), no children or remoter issue The surviving spouse (CP) will receive the deceased’s personal belongings and a statutory legacy of £450,000, and half of the residual estate absolutely.

The other half of the residual estate will pass to the parents of the deceased; if none, to brothers and sisters or issue; if none, to nephews and nieces of the deceased; if none, to the spouse.

• No surviving spouse or children or remoter issue The estate will pass to the parents; if none, to full-brothers and sisters and issue; if none, to half-brothers and sisters and issue; if none, to grandparents; if none, to full-uncle and aunts or issue; if none, to half-uncle and aunts or issue; if none, to the Crown.

25 glossary of terms

ABSOLUTE TRUST A trust for the exclusive benefit of one or more beneficiaries in specified shares. The beneficiaries become entitled to their share of the trust property on reaching age 18. Also known as a Bare Trust.

ANNUAL EXEMPTION The amount that a person can give away each tax year that will be exempt from IHT. This is currently £3,000 per year.

BARE TRUST See Absolute Trust.

BENEFICIARY A person or organisation who may benefit from a will, intestacy or a trust.

CONTINGENT INTEREST An interest in trust assets which becomes a vested interest only on the happening of a certain event.

DEEMED DOMICILE A legal concept for inheritance tax purposes where a non-UK domiciled person is treated as if they were domiciled in the UK at the time of a transfer. The person will be deemed domiciled if they have been resident in the UK for 17 out of the last 20 years.

DISCRETIONARY TRUST A trust in which no beneficiary has the right to an interest in possession, the trustees having the power to decide who will receive income and capital from the trust.

DOMICILE A concept of law which refers to the country that a person would refer to as his permanent home. For UK IHT purposes, a person’s domicile may be different from his or her residence.

ESTATE for IHT purposes means the combined total of a person’s assets and property on death.

EXCLUDED PROPERTY covers certain types of property, which, subject to certain conditions, does not form part of a person’s estate for IHT purposes.

EXEMPT TRANSFER A lifetime transfer of value that is exempt from IHT by virtue of it being covered by one of the exemptions.

EXIT CHARGE The tax charge made when there is a distribution from a discretionary trust. The calculation is based on 30% of the lifetime rate of IHT (currently 20%), i.e. maximum 6% depending when the exit charge arises.

FLEXIBLE TRUST A trust where named beneficiaries have an immediate entitlement to trust income, but the trustees have total discretion over the appointment of capital.

26 GIFT WITH RESERVATION A gift ‘with strings attached’, i.e. a gift where the donor continues to enjoy the benefits of the gift. A gift with reservation will remain within the donor’s estate for IHT purposes.

GRANT OF PROBATE is a legal document which allows the person(s) named in it to collect and distribute the assets of a deceased person’s estate.

INTEREST IN POSSESSION The immediate right to enjoy the trust property or receive income from it. The interest can be revocable or irrevocable.

JOINT TENANCY A form of joint ownership, where all parties have an equal share of the property. On the death of one owner, their interest passes to the remaining owners.

NIL RATE BAND The amount of a person’s estate on which there is no charge to IHT.

PER STIRPES Property that is to be divided among the children of a deceased person, where each child takes an equal share. If a child has predeceased the deceased, then that child’s children will take equally between them the share that the predeceased child would have taken.

PERIODIC CHARGE An IHT charge on a discretionary trust on the 10th anniversary of the trust, and every subsequent 10 year anniversary.

POTENTIALLY EXEMPT TRANSFER (PET) A transfer of value between individuals, or to a bare trust or to a trust for a disabled person, which is outside of the donor’s estate if the donor survives seven years.

RELEVANT PROPERTY refers to property to which the periodic and exit charges apply. All property settled on a discretionary trust is relevant property.

REMOTER ISSUE Grandchildren, great grandchildren (and so on) of the deceased.

SETTLOR The person who creates the trust.

SETTLEMENT See Trust.

TENANTS-IN-COMMON Joint ownership of property, where each owner has a distinct share of the property, the value of which forms part of their estate.

TRUST A legal arrangement whereby the creator of the trust transfers property to another person(s) [the trustee(s)] to hold for the benefit of another person(s) – the beneficiary(ies).

27 The information given in this document is based on Friends Provident International’s understanding of UK and Isle of Man tax law and HM Revenue & Customs practice as at December 2012, which may change in the future. Individuals are advised to seek professional independent advice and no liability can be accepted for the personal tax consequences of this Trust or for the effect of future tax and legislative changes.

Investment involves risk and each class of investment will involve its own individual level of risk. We recommend that you discuss specific risks associated with individual investments with your financial adviser before making any investment decisions.

Each policy is governed by and shall be construed in accordance with the law of the Isle of Man.

All policyholders will receive the protection of the Life Assurance (Compensation of Policyholders) Regulations 1991 of the Isle of Man, wherever their place of residence.

Investors should be aware that specific investor protection and compensation schemes that may exist in relation to collective investments and deposits accounts are unlikely to apply in the event of failure of such an investment held within insurance contracts.

Complaints we cannot settle can be referred to the Financial Services Ombudsman Scheme for the Isle of Man. (Not applicable to Corporate Trustees.)

A written statement of the policy terms and conditions of the products may be obtained from Friends Provident International on request.

Some telephone communications with the Company are recorded and may be randomly monitored or intruded into.

Friends Provident International Limited Registered and Head Office: Royal Court, Castletown, Isle of Man, British Isles, IM9 1RA. Telephone: +44(0) 1624 821 212 Fax: +44(0) 1624 824 405 Website: www.fpinternational.com Incorporated company limited by shares. Registered in the Isle of Man, number 11494. Authorised by the Isle of Man Insurance and Pensions Authority. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. As Friends Provident International Limited is a non-UK based insurer, the regulatory system that applies, in some respects, is different from that of the United Kingdom Provider of life assurance and investment products. Friends Provident International is a registered trade mark of the Friends Life group.

XIM21/GUIDE 01.14 (41406)