4th November 2013
Canada Life: The devil is in the detail – ongoing adviser charges
So far, we’ve looked at an investment bond, a discounted gift trust, and a gift and loan trust. Let’s now look at adviser charges on a flexible reversionary trust.
Peter is 68 years old and wants to mitigate his inheritance tax liability. His professional adviser recommends he invests £300,000 into a flexible reversionary trust. Peter has agreed that he will pay the initial adviser charge of £7,500 and the trustees have agreed to pay an ongoing adviser charge of £1,500 a year.
Peter has two options for paying the initial adviser charge. He can write two cheques – one to the adviser for £7,500 and one to the product provider for £300,000, or he can write one cheque to the product provider for £307,500 and the provider will pay £7,500 to the adviser at the same time as investing £300,000 into the flexible reversionary trust.
With the ongoing adviser charge, we have to remember that it is the trustees’ responsibility to pay for ongoing advice (as the trustees are the legal owners of the trust property) and, in a lot of cases, the trustees do not have access to cash – the only asset they own could be an investment bond, as is the case here.
Under the flexible reversionary trust, the 5% allowance is not available for the benefit of the beneficiaries, or the settlor, during the settlor’s lifetime. However, the trustees are allowed to take withdrawals to pay for the ongoing adviser charge and this is good news for Peter’s trustees as they have no other means to pay these charges.
But it has to be remembered that these withdrawals will impact on the chargeable event calculations for maturities or surrenders in the future. Let’s consider the impact this has.
Peter has set this initial investment as 50 sub-policies of £6,000 each, spread over an initial 10 year period with five sub-policies maturing each year.
On this basis, when the first ongoing adviser charge (£1,500) is paid (just prior to the first sub-policy anniversary), it would be divided between 50 sub-policies and withdrawn as £30 per sub-policy. Although this does not create a chargeable event at this time, it does mean there is now a withdrawal against each sub-policy of £30, which will be included in the eventual maturity or surrender chargeable event gain calculation of each sub-policy.
At the first anniversary, the trustees allow two sub-policies to mature and be paid to Peter. The other three sub-policies are deferred by the trustees to a future anniversary. What would the chargeable event gain calculation look like? Each sub-policy is now worth £6,300.
The calculation, per policy, is:
(maturity value + previous withdrawals) less (original investment + excesses)
Therefore, applying this formula to the above figures:
(£6,300 + £30) – (£6,000 + £0) = £330
As two sub-policies have matured the total chargeable event gain for Peter is £660. That calculation is reasonably straightforward but what happens in future years?
The trustees now have 48 sub-policies remaining; therefore, when the second year’s ongoing adviser charge (£1,500) is paid, it will be divided between 48 sub-policies (two sub-policies have matured and no longer exist) and withdrawn as £31.25 each sub-policy.
At the end of year two, the trustees allow a further two sub-policies to mature and be paid to Peter. The sub-policies are now worth £6,640 each. The chargeable event gain calculation, per policy would be:
(£6,640 + £30 + £31.25) less (£6,000 + £0) = £701.25.
As two sub-policies have matured the total chargeable event gain for Peter is £1,402.50.
As you can see, it will be important to keep accurate records of any ongoing adviser charges and how much is allocated against each sub-policy in order to ensure that the correct calculation is done at maturity or surrender.
If we continue on this basis, and two sub-policies mature each year, by the time we get to the calculation in year six, each sub-policy maturity would include previous withdrawals as follows:
£30 from year 1 (£1,500 divided by 50 sub-policies)
£31.25 from year 2 (£1,500 divided by 48 sub-policies)
£32.61 from year 3 (£1,500 divided by 46 sub-policies)
£34.09 from year 4 (£1,500 divided by 44 sub-policies)
£35.71 from year 5 (£1,500 divided by 42 sub-polices) and
£37.50 from year 6 (£1,500 divided by 40 sub-policies)
This example is based on a fixed ongoing adviser charge of £1,500 per annum – but bear in mind if the agreement is for the ongoing adviser charge to be paid as a percentage of current fund value, this amount will vary up and down in line with the movement in the fund value.
Alternatively, ongoing adviser charges could be taken on an ad hoc basis. Using this method the withdrawals will still be partial surrenders across all remaining sub-policies.
From a tax and accounting point of view remember – the devil is in the detail.
Cathy Russell
Tax and Estate Planning Consultant
Canada Life Limited
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