Let’s talk about Trusts: what are gifted and retained benefits?

What are retained and gifted benefits? 

In a protection context - the term is commonly used where discretionary trusts are concerned. And if you’re writing protection policies into trust it’s most likely going to be a discretionary trust you’ll 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 (we’ll refer to this as ‘benefits’ from here-on) 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. On the other hand, a ‘gifted’ benefit means the donor/settlor cannot benefit. 

Let’s look at an example. 

Donna, a client of yours, 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.

So, life assurance policies are generally considered to be a ‘gifted’ benefit. But what if Donna were to be diagnosed with a serious illness which meant she was still alive?

Well, this is where nuances between providers can cause some confusion. It’s common for providers to treat critical illness, total permanent disability, and terminal illness benefit as a ‘retained’ benefit. After all, they’re still alive and you would expect that they will need access to the policy proceeds. Some providers, such as Royal London, do things a little differently. On all Royal London trusts, critical illness, total permanent disability benefit and terminal illness benefit are classed as a ‘gifted’ benefit.

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, possibly inflating the value for IHT purposes.

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?

Wherever 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 benefit paid from a split trust is paid to the trustees and in all cases or at their instruction to the appropriate beneficiary. 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. Don’t forget that where the benefits are paid to the trustees then the trust will need to be registered with HMRC under the Trust Registration Scheme (TRS). 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.

If you’re ever in doubt about which trust form you should use for your clients situation check out Royal London’s find the right trust tool will make sure you’re always using the most suitable trust form.

Case study

You’ve arranged a life or earlier critical illness policy with a £250,000 sum assured under a Royal London Personal Menu plan for your client, Cathy and her husband, Larry. They also have a 19-year-old daughter, Haley. In the event of a critical illness diagnosis, she wants the proceeds to be paid to her but if she dies, she wants the proceeds to be paid to Larry.

Cathy and Larry have combined assets more than the IHT nil rate band therefore ensuring their life or earlier critical illness policy is arranged in a tax efficient manner is important to them.

You arrange for their policy to be placed into a discretionary split trust meaning the ownership of the plan is transferred to the trustees. Remember, because the policy has been set-up on a life or earlier critical illness basis, the policy will pay out once. Under the split trust the benefits of the policy are ‘split’. So, if Cathy suffers a critical illness this will be classed as a ‘gifted’ benefit, but if she survives the diagnosis by 30 days the trustees are obliged to pay this to her. If Cathy passes away after the critical illness claim becomes payable, but within 30 days of her diagnosis, the critical illness benefit will be held for the discretionary beneficiaries.

The proceeds paid out on death will not fall into the IHT estates of her daughter or her husband. With the trust being discretionary however, the trustees can appoint funds to her husband or their daughter or any of the other discretionary beneficiaries as required.