I love a good Netflix recommendation, mainly because it saves me (the world’s most indecisive person) spending my evenings searching for something to watch.
Someone recently recommended I watch 14 Peaks; an incredible true story of a Nepalese mountaineer who set out on a mission to climb all of the world’s 14 highest peaks (more than 8,000ft) within seven months. If you have not seen it, make sure to put it on your watch-list.
By no means an equal comparison, but I have decided to go on my own personal mission throughout 2022 to try to tackle one of the big talking points of our industry: trusts.
With only 14 per cent of protection policies being placed into trust there is an abundance of opportunity to discuss trusts with existing and future clients.
In this article we’re going to look at gifted and retained benefits and why they might be a more important advice consideration than it appears at face value.
What are retained and gifted benefits?
In a protection context, the term is commonly used where discretionary trusts are concerned.
And if you are writing protection policies into trust it is most likely going to be a discretionary trust you will be using.
Discretionary, as the name suggests, gives the trustees ‘discretion’, or in other words flexibility, to choose whom to pay any funds held in trust to and in what share.
For the purpose of setting up a trust, the proceeds or benefits from a protection policy will either be classed as a ‘retained’ benefit, meaning the person(s) setting up the trust (the donor/settlor), assuming they are also the life assured, can benefit from the proceeds paid out on a successful claim.
Or, on the other hand, a ‘gifted’ benefit means the donor/settlor cannot benefit.
Let us look at an example.
Donna, has a standard life assurance policy. Donna is unlikely to ever benefit from this policy directly because she needs to die before a claim can be made. So, it makes sense for her to gift it.
Life assurance policies are generally considered to be a gifted benefit. But what if Donna were to be diagnosed with a serious illness?
Well, this is where nuances between providers can cause some confusion.
It is common to see some insurers treat critical illness, total permanent disability, and terminal illness benefit as a retained benefit. After all, they are still alive and you would expect that they will need access to the policy proceeds.
But there are some providers that take a different approach and treat these as gifted benefits.
So, it is worth paying close attention to this on the provider’s trust form.
30-day rule
Another key point to remember when writing policies with these types of benefits in trust is the magic number 30.
Going back to our case study, assuming Donna’s policy entitles her to critical illness benefit or total permanent disability benefit, then upon a successful claim this would be initially gifted.
If Donna survives the diagnosis by more than 30 days, the benefit will revert to her under a bare trust allowing her to access the proceeds for whatever purposes she wishes. This, however, would result in the benefits now sitting in her estate, and potentially subject to inheritance tax.
If Donna unfortunately died within 30 days of diagnosis, then the gifted benefits will be held for the benefit of her discretionary beneficiaries and will be outside her estate for IHT purposes.
What trusts should be used when there are multiple benefits?
Where there are benefits that your client wants to put in trust absolutely for their beneficiaries, but also retain access to benefits like critical illness, a split trust should be used.
The trust works on the basis that the benefit is initially gifted but if the person covered is diagnosed with a critical illness and survives 30 days the trust reverts to a bare trust for their benefit. The trustees can therefore only use the money for the policyholder’s benefit from that point.
Do not forget that where the benefits are paid to the trustees then the trust will need to be registered with HM Revenue & Customs under the trust registration scheme.
Where benefits are paid direct to the beneficiaries on the instruction from the trustee, the trust is not required to be registered under the TRS.
Gregor Sked is intermediary protection development and technical manager at Royal London
