Life Assurance - a valuable tool in Tax Planning

Life assurance is generally thought of as a means of investment and of providing financial protection for the benefit of heirs on death. It can however also be used, either alone, or ideally as part of a scheme, to avoid or defer taxes such as income tax, capital gains tax and taxes levied on death. Specialist Life Assurance companies offer tailor made policies suitable for residents of many countries and will accept payment of premiums in assets other than cash.

One of the most popular methods of mitigating taxes and providing for future generations has always been, and continues to be, the discretionary trust. The trust does however have some disadvantages and one of them is that Governments almost everywhere have put in place a plethora of anti-avoidance measures designed to reduce or eliminate any hoped for tax benefits. Combining a trust with a specialist life policy can limit the effectiveness of many of these measures.

Life assurance is a contract between the Insurance Company and the policyholder. The policy sets out the policyholder's liability towards the Company, i.e. to pay a premium, and the Company's liability to the policyholder. This is, expressed simply, to pay a benefit to an identifiable person on the happening of a particular event. The manner in which the amount of the benefit is determined and when it will be paid is set out within the terms of the contract. If therefore a policyholder pays a premium of say $1 million, this sum becomes the property of the Life Company and the policyholder is thereafter entitled to receive from the company, not $1 million, but the benefit set out in the policy. In practise the Life Company may use part of the premium to purchase the life cover and use the balance to invest in a portfolio of assets. The amount eventually paid out under the policy may be calculated by reference to the value of these assets.

It follows from the above that when the Life Company invests the premium it has received, it is investing its own funds and that any income and capital gains will belong to the Company, not to the policyholder and that the policyholder therefore will not incur a tax liability. In some countries there may be tax payable if partial withdrawals are made, or when the policy matures, but the funds will still have rolled up, tax free, during the life of the policy.

Additional benefits will be secured if, shortly after it is taken out, the policyholder assigns the policy to a discretionary trust. If the policy is properly drawn, its value is likely to be small at the time and any gift or donations tax payable is likely to be relatively insignificant. When the policyholder dies the sum assured will be paid to the trust. The trust funds will continue to be held within the trust for the benefit of the heirs to conform to the estate planning intentions of the original policyholder and any tax liability will be further deferred until distributions are made from the trust.

Let us now look at some practical uses of structures such as these:

Portfolio Investment

It is not essential for the premium to be paid in cash, although of course it may be. It can instead be paid by the transfer to the Insurance Company of a portfolio of stocks and bonds. In this case the management of the portfolio can, if desired, remain with the current investment managers.

Business activities, trading

In the same way as shares quoted on a Stock Exchange can be held within a life policy the shares in the policyholder's business can be included. This will be a particularly attractive option where the business is growing rapidly.

U.K. Real Estate

U.K. real estate, particularly in London has long been an attractive investment for non-residents. For the avoidance of inheritance tax, real estate is normally held within an offshore company and the shares in the company can be held within a life policy. A two company structure may be desirable in certain circumstances.

Subject to local regulations and tax laws, real estate in other countries can be held in the same way.

Intellectual Property

The intending policyholder can sell his interest in intellectual property to an offshore company incorporated by the Life Company for the purpose. There may be a tax liability for him at this stage. Once within the offshore company that company can exploit those rights internationally in a tax efficient manner.

The above are merely four examples of assets, which can be transferred to the Life Assurance Company, instead of cash, in payment of the premium on a life policy tailored to the circumstances. In all cases, once the contract with the Life Company is concluded, future income and gains can be rolled up tax free until the policy matures or, in the case of a policy in trust, distributions are made to the beneficiaries. Similarly, effective control of the asset can remain with the policyholder or his professional advisor, subject of course to the Life Company being satisfied that it is being properly managed.

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