interest in possession trusts

[tommie12]

My father formed two interest in possession trusts in 1996; he was therefore the settlor and also named as trustee and I am also a trustee. My father is not entitled to receive anything from the trust. One of the trusts contained a single premium life investment bond, the other a life policy on fathers life.
I was appointed the current beneficiary under a revocable deed of appointment. My understanding of that appointment is that I am entitled to the income of the trust but not the capital.
Each year an amount of £2000 was paid out of the investment bond trust representing a 5% tax free drawdown. This amount would be paid to father. In return each year he would then pay back to the life policy trust an amount of £2400, representing the annual premium. My belief is that the 5% drawdown is treated for tax purposes as capital. In fathers mind he wasn't actually receiving anything from the trust, just making an annual gift to the life policy trust of £400. (a) is it as simple as that and (b) what are the tax implications of this drawdown to father followed by his payment of the annual life policy premium?

[AnthonyR]

It's difficult to give you full advice without reviewing the deeds in full, but as an initial overview:

You need to consider each trust in isolation, they are separate trusts and should be looked at separately. It's not clear whether there was a life tenant appointed to benefit from either trust, which then makes it questionable as to whether these were IIP trusts.

The life investment bond trust:
It seems, your father has retained an interest in this trust by taking a benefit from this trust (the annual 5% drawdown). Whether that's a breach of the trust deed will depend on the terms. This may mean that the trust was/is settlor interested and the value remains in his estate.

The life policy trust:

Was the policy actually transferred into the trust or just appointed as the beneficiary? If it was transferred and your father genuinely made annual payments into the trust which then paid for the policy these contributions would be covered by the annual exemption for IHT purposes, so this shouldn't cause an issue in any case. Going forward, who is the beneficiary of this trust? Usually these LP trusts are discretionary or provide an IIP to the spouse, then down to family members.

Was any advice given by the company that set up the trusts? It may be worth getting some advice on them going forward to make sure that they can still achieve the family's goals.

Finally, as a disclaimer, most of my experience is based on the post 2006 trust regime and while I have dusty old tomes cover the old system it's not something I've looked at in a while!

[tommie12]

Thank you for tasking the opportunity to reply.

In relation to the Trust containing an investment bond, the trust deed provides that the trust property must be enjoyed at all times to the absolute exclusion of the settlor and any benefit to him. Now father received the 5% tax free withdrawal although in his mind he was paying it directly back to the other trust to meet the life policy premium. It would appear that mistakenly he has contravened the Trust terms and I am wondering how that effects the trust and father and what the consequences are

[AnthonyR]

In simple terms, from a tax point of view it means that he would have retained a benefit from the trust and that the value of the bond remains in his estate for IHT purposes.

Legally the trustees exceeded their powers, although in a practical sense I assume that it's unlikely that the beneficiaries will bring a claim against the trustees (although in theory they could).

[AGoodman]

On possibility worth considering is whether the trustees of the bond trust had power to pay capital to the life policy trust. If so, your father's actions could be seen as actions in his capacity as trustee (re the £2,000) and as settlor re the £400 balance. Obviously it isn't perfect.

By the sounds of it, you would need to carefully check the powers and the respective classes of beneficiaries - in particular

(a) was the class of beneficiaries of the life policy trust a subset of those under the bond trust;
(b) was your father excluded from benefitting under the life policy trust; and
(c) was there power to advance capital to another trust and, if so, could it be exercised once the appointment had been made in your favour.

It is possible but unlikely that all are true. If not, it does sound lie breach of trust and a reservation of benefit in relation to the bond trust.