Probate trusts are simple tools in estate planning. Their uncomplicated characteristics are at the heart of their sole purpose: helping avoid the delays that come with probate (settling someone’s will after their death).
Probate trusts have no inheritance tax (IHT) implications. The objective is a fast-track process, avoiding delays on death and probate fees which can be high in some jurisdictions. Grieving families often find this more manageable, especially if they find themselves living on the breadline, through no fault of their own. They could experience huge financial difficulties because of probate delay.
In the past, all types of own life insurance policies were written subject to a trust. Without this, no death benefit from the policy could be paid until probate had been granted on the estate. This could take weeks, months or even years. Where a policy is under trust, however, provided that there is at least one surviving trustee, the life company requires few formalities. In fact, simply two items are required: a copy of the death certificate plus a completed claim form. This would allow trustees, in most cases, to receive prompt payment of policy proceeds.
This mechanism works efficiently because the surviving trustees are recognised as having legal ownership of the trust assets. So, the life company has no need to wait for probate to be granted on the estate.
However, 10 years ago the Budget of 22 March 2006 made significant changes in how probate trusts could be used by making them part of the relevant property trust regime. Ever since, families have faced a choice between two options when using a probate trust to speed up the distribution of assets after a death. The two options are a bare probate trust and a discretionary probate trust. Both still offer the same key advantages:
- The investor can still receive benefits from the policy (withdrawals or partial surrenders) if the asset is a life assurance policy
- On the policyholder’s death, the family does not have to wait for the formalities of probate to be completed, provided that there is a least one surviving trustee
Bare probate trusts
Here the trust deed transfers the asset, usually a life assurance bond, into trust where the policyholder is the sole beneficiary. They can receive future benefits from the policy at any time.
On death of the policyholder, those individuals who are entitled under the deceased’s estate become absolutely entitled to the property held in a bare probate trust. Once the proceeds have been received by the surviving trustees, they have a choice to:
- Reinvest the proceeds until probate has been granted on the deceased’s estate
- Distribute the proceeds to the beneficiaries of the estate, or
- Make a loan to them
Discretionary probate trusts
The level of complexity increases here, which somewhat goes against the grain in terms of the simple objectives of a probate trust.
The discretionary probate trust allows for flexibility after the death of the policyholder as the trustees have discretion on who to pay from a list of potential beneficiaries. This means that the trust falls within the relevant property regime, so the gift, subject to any available exemptions, to the trustees is classed as a chargeable lifetime transfer (CLT).
This means it is important to be aware of additional tripwires that could lead to a higher inheritance tax bill:
- Previous gifting to be taken into account could include prior Potentially Exempt Transfers (PETs) made within seven years of death
- Entry charges to IHT where the investment exceeds the available nil rate band
- Previous failed PETs may impact the calculation of the periodic charge if the trust still exists on any ten-yearly anniversary
- If there is a periodic charge, this will result in there being an exit charge on any benefits paid in the subsequent 10 years
- The CLT into the discretionary probate trust would be included in the cumulation count for other estate planning over the subsequent seven years
So, allowing for the removal of the tripwires outlined, the opportunity to avoid delays in payment of death proceeds must be firmly grasped.