Split Trusts

Family protection policies

These trusts are often used for family protection policies with critical illness or terminal illness benefits in addition to life cover. Split Trusts can be Bare Trusts, Discretionary Trusts or Flexible Trusts with default beneficiaries. When using this type of trust, the settlor/life assured carves out the right to receive any critical illness or terminal illness benefit from the outset, so there aren’t any ‘gift with reservation’ issues.

In the event of a claim, the provider normally pays any policy benefits to the trustees, who must then pay any carved-out entitlements to the life assured and use any other proceeds to benefit the trust beneficiaries.

Trade-off
If terminal illness benefit is carved out, this could result in the payment ending up back in the life assured’s Inheritance Tax estate before their death. A carved-out terminal illness benefit is treated as falling into their Inheritance Tax estate once they meet the conditions for payment.
Essentially, these types of trust offer a trade-off between simplicity and the degree of control available to the settlor and their chosen trustees. For most, control is the more significant aspect, especially where any lump sum gifts can stay within a settlor’s available Inheritance Tax NRB.

Maximum control
Keeping gifts within the NRB and using non-income-producing assets such as investment bonds can allow a settlor to create a trust with maximum control, no initial Inheritance Tax charge and limited ongoing administrative or tax burdens.

In other cases, for example, grandparents funding for school fees, the Bare Trust may offer advantages. This is because tax will fall on the grandchildren, and most of the funds may be used up by the age of 18. The considerations are slightly different when considering family protection policies, where the settlor will often be dead when policy proceeds are paid out to beneficiaries.

Policy proceeds
A Bare Trust ensures the policy proceeds will be payable to one or more individuals, with no uncertainty about whether the trustees will follow the deceased’s wishes. However, this can also mean that the only solution to a change in circumstances, such as divorce from the intended beneficiary, is to start again with a new policy.

Settlors are often excluded from benefiting under Discretionary and Flexible Trusts. Where this applies, this type of trust isn’t suitable for use with joint life, first death protection policies if the primary purpose is for the proceeds to go to the survivor.