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Estate Planning with Trust-Owned Policies: A Closer Look

Have you ever wondered how to ensure a smooth business ownership transition after your passing while also providing for the tax burden on your loved ones? Using trusts as estate planning vehicles, particularly to house shareholding, can be a powerful tool to achieve both these goals. However, neglecting crucial tax and other implications can lead to significant gaps in your overall estate and liquidity planning.

Understanding Trusts: Ownership and Purpose

To fully grasp the envisioned strategy, it’s crucial to first understand the nature and purpose of a trust. The Trust Property Control Act defines a trust as an arrangement where ownership of property is transferred to a trustee for the benefit of another person (beneficiary). However, unlike a company, a trust itself isn’t a legal entity. Essentially, you place assets in the trust, and a designated trustee manages them according to your wishes outlined in a trust deed.

Trust-Owned Policies and Estate Duty: A Common Misconception

Many believe that a “buy-and-sell” policy (which is supported by a buy-and-sell agreement) owned by a trust is automatically exempt from estate duty. This isn’t the case if the trust holds the shares in the company. In such scenarios, the policy remains a deemed asset for the life insured for estate duty purposes.

The only estate duty benefit if the trust itself pays the premiums, owns the policy, and is the beneficiary. is that the premiums paid, with compounded interest, can be deducted from the proceeds of the policy, thus reducing the estate duty. The estate duty exemption only applies if the policy is owned by a natural person; a trust is not a person.

Let’s look at an example. Bob and Sam are business partners who run a successful company together, with each of their shares owned by separate trusts. To ensure a smooth transition of ownership in case one of them passes away, they decide to take out a “buy-and-sell” life insurance policy. The policy will pay out a lump sum to the surviving partner upon the death of either Bob or Sam. The trusts own the policies, pay the premiums, and are also the beneficiary. Here’s how it works:

  1. Ownership and Premiums:
    • The trust pays the premiums for the policy.
    • The trust is the beneficiary of the policy.
  2. Estate Duty Implications:
    • If Bob passes away, the policy proceeds will be paid to Sam’s trust.
    • Since the trust owns the policy, it becomes an asset for estate duty purposes in Bob’s estate.
    • Sam’s trust can use the policy proceeds to buy out Bob’s trust’s share in the business.

Trust Deeds and Policy Permissions

Beyond tax implications, the trust deed itself plays a vital role. It’s essential to check if the trust deed allows the trust to take out a life insurance policy in the first place. Additionally, the deed might restrict who the policy can cover – a trustee, a beneficiary, or perhaps both.

Crafting a Well-Rounded Estate Plan

While trust-owned policies can be a valuable tool, they require careful planning and consideration of tax implications and trust deed provisions. Consulting with a qualified estate planner is crucial to ensure your strategy aligns with your goals and doesn’t cause unnecessary burdens for your beneficiaries.

They can guide you through the process of establishing a trust, selecting appropriate assets, and choosing the right type of life insurance policy. With a well-crafted estate plan that incorporates trust-owned policies, you can ensure a smoother business ownership transition.

If you have any questions or need further clarity on any of the points discussed and the associated tax considerations, we encourage you to seek advice from your tax consultant.