1. The current inheritance tax thresholds
2. The Family Home Allowance
3. Avoiding the IHT trap
4. Using the Whole of Life investment contract
5. The IHT calculator
6. How to create contract affordability
7. The requirement for flexibility
8. The use of Guaranteed Insurability options
9. What if a client downsizes and there are changes in circumstances
PRESENTER: In this learning module on Akademia, we’re going to be looking at inheritance tax planning strategies and in particular using protection in IHT planning. Our tutor is Nathalie Claeys, a very experienced protection specialist from Old Mutual Wealth. Let’s run through what we’re going to be covering.
First of all, Nathalie is going to discuss the current inheritance tax thresholds. Then she’ll explain the recent significant change, the family home allowance, what is it and what it will eventually mean to property owners. What advisers can do to help clients not to fall into the inheritance tax trap and in particular how the use of regular premium solutions may help to fund the IHT bill. By the end you will understand what is an appropriate point in discussions with clients to talk about inheritance tax planning, how to help them mitigate their exposure to potential IHT liabilities, and through a case study we’re going to be looking at what is available to help you consider the appropriate areas for the appropriate solutions in IHT planning. Using whole of life protection and whole of life contracts, rolling term protection contracts, guaranteed insurability options, downsizing and changes in clients’ circumstances. We’ll be mentioning a number of useful documents, and there’ll be links to those on your screen. So let’s now hear from Nathalie Claeys.
NATHALIE CLAEYS: According to Benjamin Franklin, writing a letter in 1789, “In this world nothing can be said to be certain except death and taxes.” And never has a truer word been spoken with regards to inheritance tax. Inheritance tax is potentially payable by everyone who is UK domiciled. It is based on the value of an individual’s worldwide assets, and also on the UK assets of non-domiciles. The first £325,000 of every estate is covered by the nil rate band. This is called the inheritance tax threshold, and has been frozen by the Government at £325,000 until at least 2021. Estates incurring inheritance tax charge of 40% above that level, while married couples and civil partners are entitled to double this allowance, or £650,000 before tax is payable. To provide some context this compares with the United States where the threshold stands at £3.7m, and yet is still the source of considerable political controversy.
The Government did however announce some significant changes to inheritance tax in the summer budget. Instead of increasing the tax free threshold for everyone, George Osborne introduced the family home allowance, an additional main residence nil rate band which will be applied when passing on a residence to a direct descendant. This allowance will be phased in over four years beginning in 2017 at a starting rate of £100,000. Eventually it will be worth an additional £175,000 per person. Now added to the £325,000 allowance available under the nil rate band currently, this means a new allowance for property owners of £500,000 or indeed £1 million for couples.
But has he done enough? The Government’s own forecasts show almost 60,000 estates will be liable for inheritance tax by 2021, which represents an approximate doubling of today’s figures. Over the same period inheritance tax receipts are forecast to rise from just over £4bn in the current tax year to almost £6bn. And with Halifax in May releasing figures showing house prices currently increasing by over 10% per year, this is clearly an area that requires careful planning. The role of advisers to help prevent clients from falling into this inheritance tax trap through carefully considered inheritance tax mitigation strategies is vital. There are a variety of options available to an adviser, ranging from trust based planning through to business relief qualifying trades. But for now we’re going to concentrate on the use of regular premium solutions to fund the inheritance tax bill. Simply put we’re looking at whole of life insurance contracts.
PRESENTER: And now we’re going to the Akademia studio where I will first ask Nathalie about where IHT planning fits in the financial planning process. Nathalie, at what point in the financial planning process should a financial adviser bring up inheritance tax planning?
NATHALIE CLAEYS: It’s a good question, actually, and possibly more often than they generally do. When it comes down to any type of financial review with a client, there’s a variety of factors that need to be taken into account. So we generally work through what we call a hierarchy of needs. And that could be anything from borrowing, outstanding debt. It could be the client’s aspirations in terms of savings and investments, tax planning, retirement saving as well as estate planning, one of those areas are mutually exclusive, and what order a client prioritises those discussion is based on different factors. It could be their age at a time, so for example…
PRESENTER: Presumably as people get older IHT comes onto the horizon does it not?
NATHALIE CLAEYS: Exactly, so unless you’re looking at a very complex estate you generally tend to find clients aren’t really open to those types of IHT discussions until they hit maybe their late 40s or late 50s. So again that’s taken into account: marital status, do they have children, what their immediate aspirations are. So as an adviser you work through the hierarchy of needs and you work in consultation with your client to work out what their individual priorities are. But IHT planning in terms of whatever an adviser does for a client in terms of increasing their wealth, be it capital growth or income long term, it’s very important that the more successful they are at that, the worse the problem becomes in terms of IHT in the long run.
PRESENTER: A will is always a good thing to have to begin with is it not?
NATHALIE CLAEYS: It’s a great place to start, definitely.
PRESENTER: Absolutely right. Just in this hierarchy of needs, just talk to me a little bit about where pensions fit into IHT and where maybe ISA funds fit into IHT or not now.
NATHALIE CLAEYS: In terms of whether or not they end up extending or increasing the liability, pension funds if they’re held in a trust for the most part aren’t taken into account, so we can ignore those from an asset perspective, increasing the value of the estate. ISAs are effectively wrappers, they’re not products. So anything that’s held in an ISA, although it’s tax free in terms of income tax, is liable to IHT. So they will increase the value of the estate, and if it goes above that threshold of £325,000 could potentially be liable for the 40%.
PRESENTER: So how does an adviser go about helping a client in their rearrangement of their affairs in order to mitigate potential IHT liability?
NATHALIE CLAEYS: I wish I could sit here and say to you that from an advising perspective it was just a case of making a decision and working with the client. The key really to successful IHT mitigation is starting as early as possible. Now the simplest way of achieving that is to try and bring the taxable value of your estate below the nil rate tax band threshold of £325,000. And there are different ways that you can effectively achieve that. You mentioned about having a will, making sure the money goes to the right person or persons going forward, that’s very important. If you don’t do that you rely on the rules of intestacy and it could be you’re incurring more tax as a result than you would like to. Linked to that is lifetime gifting. So giving or transferring away money or assets from within your estate.
Now those transfers between married couples or civil partners are exempt from tax, so that’s a great way to start, and again supported by the will if you’re passing on those assets to a spouse or civil partner. In addition to that moving assets or transferring them into trusts is a great way of going about it. Because as soon as you place it into a trust it moves it out of the estate. Potentially even donations to political parties or charities, all of those will go some way towards reducing the value of the taxable estate and driving it below that £325,000 threshold.
PRESENTER: So in a sense today what we’re talking about is the residual, the lump sum. Having done all those things that you can possibly do, you’re still left with a lump at the end that is going to potentially create an inheritance tax liability. Is that really what the essence is?
NATHALIE CLAEYS: It is. That’s what we’re going to use a case study to support in terms of that end figure. I think one thing that’s very important to reassure advisers about and certainly clients is to avoid oversimplifying the process. As I mentioned it’s not a static decision to make a decision and to introduce a solution that represents mitigation of IHT; it’s an ongoing relationship and conversation that an adviser has with a client. So for example we mentioned transfers between married spouses being exempt. You can transfer to other individuals, but potentially those transfers won’t be free of inheritance tax for at least seven years following the transfer.
So again it’s recognising that whatever solutions are put in place we don’t want to oversimplify them today, but the reality is this conversation is one that started hopefully as early as possible and is an ongoing conversation that an adviser has tailoring that solution to meet the changing needs and liability of that particular client.
PRESENTER: Part of a regular review.
NATHALIE CLAEYS: Absolutely.
PRESENTER: OK, fine. Well let’s move on then to our case study. We’ve got some slides to help us through this. I believe we’ve called the couple Thelma and Bob.
NATHALIE CLAEYS: We have, absolutely. Bob and Thelma are a 60-year-old non-smoking couple. They’ve got to a point now where they’re seriously thinking about what concerns or what issues they might have with inheritance tax. As with any client they’re worried about the cost of any type of mitigation solution. Between the two of them they have a house that’s mortgage free. They live in the country. Their children are grown and they’ve just received their first grandchild. Thelma’s retired currently. She’s receiving maybe £12,000 per annum from a small pension. And between the two of them they have maybe £300,000 in a pension pot. Bob’s still working but we’re hoping to change that fairly soon.
PRESENTER: And Bob’s not in particularly good health or what’s the situation there? Because that’s often a crucial part of people’s planning.
NATHALIE CLAEYS: We do find that. The older we get the more likely we are to find ourselves subjected to, I don’t know, worsening medical conditions. We might start smoking, although that’s not the case in this instance. But yes he’s in a situation where he’s not retiring due to ill health. But we are finding that his health is suffering a little bit. So again we’re worried about what solutions we can offer, and also the cost of those to this particular couple.
PRESENTER: Now they have an Aunt Maud.
NATHALIE CLAEYS: They do, I think we all have one somewhere don’t we?
PRESENTER: Somewhere along the line, yes indeed. That’s a real name from the past, Aunt Maud, so what’s going to happen with Aunt Maud?
NATHALIE CLAEYS: One thing we mentioned as we were speaking just before we introduced the case study is that nothing with regards to an individual’s wealth level, tax mitigation strategy is ever static, it’s always moving, and in this particular instance we’ve got a change to the amount of money that’s hitting their particular estate. So we’ve got Aunt Maud. She’s been very generous. She’s passed unfortunately from this mortal coil and she’s left them £300,000 in terms of inheritance. So what we will go on to do is take a look at what impact that could have on the taxable estate and subsequent liability, and also what we can do as providers to support advisers who are looking to accommodate those changes for the client in the future.
PRESENTER: Now just then on this next slide step us through their assets and their value, and what your left with in the end as this lump that we’re talking about.
NATHALIE CLAEYS: Let’s take a look through. They’re in a wonderful position. The house is effectively liability free, the mortgage is cleared, so we have an estimated value on their country home of £600,000. They also have some additional assets. They have a boat for £25,000 in terms of value. Household contents, personal effects, we’re looking at around about £40,000. Bank and building society savings close to £70,000 so they’re not short of money that’s been put aside. Stocks and shares and investments that have potentially been invested for the longer term, we’re looking at around £50,000. Life policies, these aren’t in trust. They actually have made provision in terms of a life policy in the past. It’s worth £500,000 when it pays out.
I want to pause at this point because most advisers will be stopping and saying look Nathalie with respect wouldn’t that policy be in trust?
PRESENTER: In trust, yes absolutely.
NATHALIE CLAEYS: And therefore remove that value from the estate. And I would absolutely agree with you. We’re very fortunate at Old Mutual, we do an awful lot of estate planning, and as a result we have a high proportion of our policies held in trust. Unfortunately in the rest of the market maybe something like 10 to 12% of policies, life policies, are written in trust. So it’s a very small proportion. So while I would absolutely agree the best thing to do is put this policy in trust and remove that £500,000 from the estate, the reality is we do find that most clients will approach an IFA and they will be in a positon where it’s not.
PRESENTER: It’s relatively easy, I say relatively easy, to write these policies in trust, is it not?
NATHALIE CLAEYS: Yes.
PRESENTER: And it should be done.
NATHALIE CLAEYS: Absolutely, I mean there are always different circumstances.
PRESENTER: You and I agree on that.
NATHALIE CLAEYS: No, we absolutely agree. I mean there are different implications in terms of tax positioning and the type of policy, but the reality is unless you want to be looking at paying 40%, whatever those tax implications could be, I would suggest they’re going to be lower than the 40% you’re likely to pay.
PRESENTER: All right, the last two or three things on their assets, pensions.
NATHALIE CLAEYS: We have, we’ve got an estimated value as we said of £300,000 and we have credit cards of approximately £10,000.
PRESENTER: Great. So what are the key considerations, what should an adviser be considering with Bob and Thelma as they move into thinking about inheritance tax planning?
NATHALIE CLAEYS: Well the first thing as we’ve said is assuming that we’ve had an ongoing conversation with these clients about efforts they could have made to mitigate IHT liability in the past. The first thing we need to do is make sure that we actually calculate accurately the extent of the liability. And one of the things we can do is make sure that we have the tools available to advisers to support that conversation and that calculation. So calculating the tax liability has got to be the first place to start; let’s see how big a problem this actually is for the client, if at all. Once we’ve established that, we’re looking at regular premium solutions.
So it’s recognising that there are contracts out there that can support this mitigation exercise, and it’s looking at the extent of those options and how they best suit the client. Not just in terms of their ability to afford the policy now, but again as we said as their needs might change in the future when Aunt Maud inheritance tax actually hits the estate, how we can adapt those solutions to continue to support the client if their liability changes. Tax efficiency is a big one. You touched on the trust element of it being relatively easy. We’ve got to make sure that whatever solution we put in place is set up in as tax efficient method as possible, and that’s got to be about exploring some of the different trust arrangements there are available in the market. And there are more than one effectively that an adviser can utilise.
Funding is very important. We have an obligation as advisers to ensure that whatever solution we put in place is affordable not just when they take the policy out, but certainly as our income changes from earned to retired that long time it’s affordable and manageable.
PRESENTER: And that it’s affordable when they’re perhaps 85.
NATHALIE CLAEYS: Absolutely, because we are looking at solutions that will run potentially until the client dies. There are different ways that you can achieve that, and it’s important that an adviser looks at the different options available. So in terms of potential funding, ideally you’d want that driven by earned or later retirement income. But we have advisers who are utilising bond income for example, and I notice that obviously Bob and Thelma do have investments, could be that could drive that supporting premium payment. We have children paying premiums because ultimately they’re the ones that will benefit from that payment.
PRESENTER: That’s an interesting one, yes.
NATHALIE CLAEYS: To pay for the IHT liability.
PRESENTER: I can imagine that conversation, yes.
NATHALIE CLAEYS: It’s a good family conversation topic, I’m sure. And more recently with things like pension reform we’ve seen premiums being paid from income withdrawals via flexi-drawdown facility, or possibly using a tax free lump sum to purchase a lifetime annuity, and using the income derived from that. So there’s a variety of different funding solutions, but ultimately we have to make sure that long term these solutions remain affordable to the clients.
PRESENTER: Indeed, that people are not depleting their lifestyle, because they’re having to pay for this insurance policy.
NATHALIE CLAEYS: No, absolutely.
PRESENTER: It is quite a complex process, what is available to help advisers work through it with clients? Or do you suggest that advisers don’t work through it with clients; they work it all out beforehand and present the solution?
NATHALIE CLAEYS: I think it’s a little bit of both, it is. I mean it can be.
PRESENTER: Well you don’t want to frighten people.
NATHALIE CLAEYS: No, we don’t want to. But similarly I’m not going to lie and suggest that some of these solutions can’t be quite complex, because I guess the more wealthy or complex the estate a client has, the more complicated that conversation is likely to be. Similarly we’ve talked about gifting away money, assets etc., depending on how effectively that’s done you could have liabilities that are depleting or extending in terms of IHT throughout the course of the client’s lifetime. So absolutely there are tools and technical support that providers like ourselves have available, and one of the ones we’re going to look at relative to Bob and Thelma is the inheritance tax calculator that we’ve got available.
PRESENTER: Let’s have a look at that inheritance tax calculator.
NATHALIE CLAEYS: Just talking through some of the assets and liabilities that we discussed from earlier, you can see the value of the main home in terms of assets is there with the £600,000, and as you can work through you can see the additional assets they have in terms of the boat, the personal contents, again the savings in the short-term deposit facilities, the banks and building societies, as well as these long-term investments, they are all there within that. So the estimate value of those is all popped in the calculator. Again we’ve had to pop the £500,000 in there for the life policy that’s not in trust, because we’re trying to keep this a realistic exercise. And again it comes to a total estate value if you like of £1.285m value.
PRESENTER: And that £1.285m value is today’s value; it’s not a projection of what it might be in five or ten years’ time.
NATHALIE CLAEYS: No, you’re absolutely right. It’s at any one point in time; it’s the value of assets as they stand when it’s been calculated. The calculation doesn’t stop there. If we take a look at the next slide, what you’ll see then is the deduction with regards to your outstanding liabilities. And we’ll see here that there are credit cards of £10,000, they would need to be deducted; similarly had this couple had a mortgage liability, that value of liability would also be deducted. But in this case they’re mortgage free; it’s just the £10,000 we’re taking off.
PRESENTER: So you end up with this lump again.
NATHALIE CLAEYS: You do. Unfortunately there’s an awful lot less to take off than there is to add on. So what we’re left with, when we take into account their nil rate tax band as we said earlier, they each have £325,000 which is their threshold. That applies to both of them. So we take that £650,000, we pop it into the calculator and what we’re left with is an inheritance tax liability at 40% of £250,000 for this client.
PRESENTER: So for the purposes of this case study we’re looking at an inheritance tax potential liability of £250,000.
NATHALIE CLAEYS: Absolutely, if nothing changes.
PRESENTER: So how are we going to fund that, how are we going to do anything to that? We can’t mitigate it any more, that’s what it is today.
NATHALIE CLAEYS: It is. In terms of, I guess, the most effective protection solution that’s available, you’re looking at a whole of life contract; for this couple set up on what we call a joint life last survivor basis. A whole of life contract differs from a traditional term life assurance contract in that it doesn’t have a term. It’ll continue to run for as long as the client keeps paying the premiums, or until they actually pass away. By setting this policy up on a joint life second death basis, what we’re effectively doing is delaying the pay out until the second person within that couple actually passes away. Because they’re married, any transfers after the first person dies are exempt of inheritance tax. So the inheritance tax liability that we’re talking about will only hit when the second person has actually passed away.
PRESENTER: So what does this solution ideally look like?
NATHALIE CLAEYS: I’m going to bring you back to trusts again. The life insurance policy for those that write insurance policies, it’s underwritten on both lives but is generally cheaper than a traditional joint life first event policy, because again we’re waiting for that second life to have passed before the policy actually pays out, because that’s when the liability hits. Ideally you’re looking for it set up in a trust arrangement. Now there are a variety of trust arrangements they can use. They range from absolute or bare trusts, through to flexible, through to discretionary. Generally for inheritance tax the most commonly utilised trust is what we call a discretionary trust with settler excluded. So it would be settler, i.e. the person that owns the policy, isn’t benefiting from that trust arrangement in any way. And again it doesn’t incur any IHT liability as a result.
PRESENTER: So we’ve got this whole of life contract inside a trust.
NATHALIE CLAEYS: Yes, keeping it free from the estate and not making the situation any worse.
PRESENTER: And how do you make that affordable?
NATHALIE CLAEYS: That’s an interesting one actually. Because there are different ways that you can effectively approach that. I’ve been in financial services for a while, though I’ve been specialising in protection for eight years. In terms of the cost of whole of life contracts, it’s probably one of the more expensive contracts to insure yourself under, just because by definition it will insure you for as long as you happen to survive for. There are different ways that you can achieve that affordability. The first is to ensure actually that there is sufficient provision going forward. So a traditional whole of life contract is guaranteed in premium. What that means is that premium is static for the whole time that that policy exists. So it makes it very easy for a client to work out how much it’s going to cost them and to make sure for the adviser they have sufficient resources in place to keep accommodating that.
There are a variety of other solutions that are available that provide what we call low cost alternatives. So again it’s very important for the adviser to have those discussions with the client to make sure that short term as well as long term those aspirations and affordability restraints are actually met and managed.
PRESENTER: So we’ve got this whole of life contract, we’ve got it in a trust and we can afford it. What happens if circumstances change and you need to be flexible?
NATHALIE CLAEYS: Absolutely, we laughingly refer to that as future proofing. I know it doesn’t sound particularly insurance based.
PRESENTER: No, I’m cool with that.
NATHALIE CLAEYS: But it’s the most effective way for us to describe how we go about ensuring that going forward we have that flexibility. So there’s a variety of ways. There’s two ways that flexibility tends to be required with this type of protection solution. It tends to be with what we’ve seen with Aunt Maud inheritance tax that liability increases for some reason, and there’s a need to increase the sum assured, i.e. the amount the client’s insured by, by the same amount. And ideally as we’ve seen with Bob, he’s slightly poorly, we kind of want to do that without any underwriting. That’s really key to avoid a client having to go through that quite intrusive process sometimes again.
The opposite is also true. So we actually see more active mitigation strategies where the client has done all the things that their adviser’s encouraged them to do, and we have a situation where they actually might need less cover now, because the actual taxable value of their estate has diminished to a point where their liability has decreased.
PRESENTER: They’ve given away more than they thought in the first place.
NATHALIE CLAEYS: Yes, they’ve just done a really good job of making sure the tax man doesn’t get the 40%. And what we try to do is provide more flexible features within our protection solutions to allow both of those things to happen depending on the changing needs of the clients.
PRESENTER: Talk us through these steps step-by-step for Bob and Thelma. So let’s look at this first slide about guaranteed whole of life and the £250,000. How does that work?
NATHALIE CLAEYS: Let’s take a look through. What you can see in front of you is a visual representation of, the guaranteed or stability aspect of whole of life. Now guaranteed whole of life is still the bedrock financial planning contract when it comes to IHT mitigation, clearing that liability. And the reason it’s so popular is because it has certain specific advantages. The first is certainty. It’s certainty of cost because you know exactly what you’re going to pay, and those premiums are static as you can see on the slide throughout the term of that contract, unless the client makes the change themselves. There’s also certainty of outcome as well. Because by definition it will insure you until any point you die. You’re not running a risk of your 25-year term finishing and you dying in year 26 for example. So certainty is one of the main advantages of it.
The tax efficiency side of it, so recognising that placing this insurance policy into a trust moves it out of the estate. Basically encapsulates it within a bubble that hovers outside the estate, that provides the right type of payment, as in the right amount, as quickly to the trustees as possible, and it avoids the situation where you’re waiting for probate to have been effectively processed and gone through before any money is made available.
PRESENTER: Because inheritance tax is liable, payable almost immediately on death, that’s right isn’t it?
NATHALIE CLAEYS: It is. So if the estate is going to be subject to probate, which I would suggest is going to happen with the values that we’re dealing with, then unfortunately probate does have to be gone through, and the money needs to be paid in terms of satisfying that inheritance tax liability before any assets can be released. You’re in very much a catch 22, you can’t get hold of the money to pay the liability, and unfortunately you can’t release the assets until the liability is paid.
PRESENTER: No, indeed, and if the tax man wants the money he starts charging interest if you don’t pay it.
NATHALIE CLAEYS: Potentially you could be facing that as well.
PRESENTER: So the guaranteed whole of life contract is the bedrock.
NATHALIE CLAEYS: It is. I wish I could say to you that it was an inexpensive solution but it’s not. Any advisers that have dealt with inheritance tax planning and utilised these types of whole of life contracts before will find that very rarely does a client walk into their office saying please I’ve got a £250,000 liability, I’m absolutely desperate to spend in this case £237, sign me up. It’s just not what happens. So the reality is clients do tend to find that they are uncomfortable with that level of premium, in this case over £230. And as a result they are looking for either to take less cover, which does leave them exposed unfortunately, so not the entire liability being covered, or potentially they just don’t look to take the policy at all, and they leave themselves completely exposed.
PRESENTER: So do you have a solution to those quandaries?
NATHALIE CLAEYS: We do. The third advantage of whole of life is the ability to demonstrate its cost efficiency. And there are different ways that we do that. But if you take a look at the next slide, one of our additional whole of life contracts is one we call our rolling term or our stepped whole of life, which is how our advisers like to utilise it. What you’ll see in front is the same liability, so the client is covered for the full £250,000, but it’s a renewable contract insofar as the premiums are guaranteed in tranches of 10 years. So the clients are 60, the policy is also set up on a joint life last death basis, and the premiums which start at £84 a month are guaranteed for a 10-year period. On that 10-year renewal the premiums will increase again, they’ll go up to £220, and they’ll do that every 10 years. What you have is a considerable cost saving during that first 20-year period against an equivalent whole of life contract at £237.
PRESENTER: And people are more happy with this, they may at the age of 90 be paying £1,404 per month, is that at today’s prices or is that potentially going to increase when somebody’s 90? Because £1,404 in 20, 30, 40 years’ time isn’t going to be as much as it sounds today.
NATHALIE CLAEYS: The answer to that question is yes and no. So yes you’re absolutely right, the beauty of our particular renewable contract is that we actually guarantee all the future premiums at outset. And the problem that we’ve had with renewable contracts or the old unitised investment linked whole of life contracts in the past, where they were great at the cost saving and the clients were very attracted to them, but the reality was the client never knew what they were going to pay in the future. So what we’ve tried to do is give the client, in this case with rolling term, the benefit of the lower cost upfront start for the first 20 years in this case. But guarantee all their future premiums at outset. So the premium rate set is established at outset, and the client’s age is the only factor that changes the premium at each of the 10-year renewal points.
PRESENTER: And let me just be absolutely clear, this is for a policy on the couple.
NATHALIE CLAEYS: It is.
PRESENTER: Both Bob and Thelma are covered for this.
NATHALIE CLAEYS: That’s absolutely right, exactly the same.
PRESENTER: And if Bob should unfortunately die earlier Thelma is still covered.
NATHALIE CLAEYS: She is until she goes, and that’s when the policy will pay out. It isn’t, certainly as we’re talking about it with advisers, and it’s very much increasing in popularity. It’s not a policy that we feel is better than a traditional guaranteed whole of life. But the reality is clients are very concerned about the cost. And Bob and Thelma are no different in that respect. There are two ways that you can approach that. Either the client takes less cover than they need, or they just get so turned off by the cost of it that they just choose not to pursue.
PRESENTER: And say I’m not going to be here and therefore I don’t care.
NATHALIE CLAEYS: Yes exactly.
PRESENTER: You can hear that.
NATHALIE CLAEYS: So hopefully this gives them the opportunity to consider the entire insurance amount being covered of £250,000 at an upfront cost that’s a lot lower potentially than the equivalent whole of life. But at the same time it also gives them 20 years to have that regular conversation with the client, because it could be that they have those IHT mitigation strategies that they can start utilising during that period. So what we hope is going to happen is before they get to a point where that premium really jumps up, they can drag their sum assured down because their liability has reduced accordingly.
PRESENTER: Here’s a question for you. If you should find that your inheritance tax liability reduces from £250,000, are you able to change this particular rolling term contract?
NATHALIE CLAEYS: Absolutely, any of our insurance contracts, in fairness insurance contracts in the market, we’re quite happy to reduce at any time. We don’t have a problem. But certainly it’s very popular at the 10-year renewal points the client isn’t underwritten, that’s the point where they do tend to make an informed choice about do they need to bring that level of protection down to correspond with a lower liability.
PRESENTER: Now there are some people that would say paying for an insurance policy is a waste of money, or it’s dead money. You know, effectively you don’t see it as part of your income, because you don’t see it.
NATHALIE CLAEYS: Yes.
PRESENTER: What would you say to them?
NATHALIE CLAEYS: I would say that’s actually a very common objection. And we tend to find it more, because this area of more complex estate and inheritance tax planning tends to sit within the wealth management sphere, we tend to find that those clients and also those advisers are much more investment orientated. So that £237, an investment orientated client would think why wouldn’t I just take that money Nathalie, and why wouldn’t I invest it? Because I can’t see this insurance contract, it’s not growing, it’s not, I can’t feel it, touch it and see it being increased each month or each year.
PRESENTER: Indeed, it’s not like a savings, it’s not like an investment in that respect.
NATHALIE CLAEYS: No, and it doesn’t feel quite as good to a client to know that their money’s going to an insurer as opposed to into a fund that they’re investing into. It’s very rare when you get that type of objection, advisers will not recommend a policy a client can’t afford. That’s why they recommend, to make sure that it is available short as well as long term. So if a client is raising that objection, why should I spend that money, it’s not because they can’t afford it, but it’s more they just don’t see the value of paying that premium along the lines we discussed.
If an adviser is getting that objection, there’s two ways I’d approach it. The first is a selling technique that we encourage, whereby where a client has identified, where an adviser has identified a liability, in this case of £250,000, rather than approach a client with a whole of life guaranteed solution of £237, and it’s would you like this or not? You introduce both the rolling term, the stepped whole of life, and the whole of life solution. Firstly it becomes which of the two solutions do you feel is most suitable for you? So it’s an either/or, not something or nothing.
PRESENTER: You’re sounding like an insurance salesman.
NATHALIE CLAEYS: Well I am.
PRESENTER: That sounds like an alternative close to me.
NATHALIE CLAEYS: But in fairness that’s what it is, it so does. The other thing as well is in terms of relative value, it’s a very powerful way for clients to recognise the importance of what they’re doing. So for example if you go back to old school relative value, a client, are they prepared to spend £60 on a policy? No, but you’ll spend £2 a day on coffee which is the equivalent. So relative value can be very powerful as a positioning concept. When you have the two together, if a client is baulking at the whole of life premium at £237, suddenly the rolling term solution, the stepped at £84 becomes much more palatable for them. But similarly as you raised earlier, when the premium in the future goes up to over £1,000 a month, suddenly that solution isn’t attractive, and the £237 that’s guaranteed, that suddenly becomes much more attractive. So it isn’t so much about how the client is accepting the actual policy itself, but more how the adviser just introduces the two. And relative value is very powerful. That’s the first way of doing it.
The second way is the cost effectiveness. So recognising the value of a whole of life almost as a form of non-correlated or guaranteed investment, and certainly investment orientated clients are suddenly much more open to that type of discussion. So if you can take a look at the slide. It’s the same liability, and I’ve taken that guaranteed whole of life premium at £237. And I’m supporting the desire for the client to invest that money instead of effectively insuring it. I’ve taken that £237 and I’ve assumed a net return of 4%, because that’s quite realistic, and I’ve saved that money. The good news is to achieve a fund value, an investment value of the £250,000 I need, it’s going to take me 38 years to save that money at 4% net return to achieve £250,000, which is fabulous. The problem is it’s going to take me 38 years to grow that money, but my clients are likely to have left me in 27. And what I’m left with is a deficit.
So suddenly if I were to take that £237, in order to achieve the payout of £250,000 I would need to achieve a net return of not 4% but closer to 8%. And in this market it’s a very big ask. If an adviser can achieve that type of net return fantastic, in fairness I’d probably want to be investing my money with them as well, but the reality is that’s a big ask. So suddenly the value of that contract in terms of the amount it pays out relative to the contributions to it becomes again, it resonates with an investment client much more effectively.
PRESENTER: So effectively you’re offering on this particular contract an 8% return.
NATHALIE CLAEYS: Yes, so we’re demonstrating the value in terms of that net return yes. Even though the contracts themselves have no investment element, they are pure insurance, it’s a different way of delivering the value of it in a way that might relate to an investment client more closely.
PRESENTER: It’s uncorrelated because it’s not linked to the stock market or to bond prices or.
NATHALIE CLAEYS: Political changes, Brexit, nothing at all.
PRESENTER: All right, that’s a really interesting discussion to have, 8% return on an insurance contract.
NATHALIE CLAEYS: It becomes a very powerful conversation piece, I think.
PRESENTER: Right, that’s not the end of the conversation though. So we move on from there, future increases in estate value. Remember that Bob and Thelma suddenly or perhaps not so suddenly get £300,000 from a Great Aunt Maud’s estate.
NATHALIE CLAEYS: That’s right.
PRESENTER: Indeed, so how can you build into this activity the flexibility to cope with something like that?
NATHALIE CLAEYS: The good news is on a generic level most protection policies will allow you a certain degree of flexibility to cope with an increase in the sum assured. We principally achieve that through our guaranteed insurability options, and there are specific ones that support changes to inheritance tax liability, or inheritance tax rate bands effectively, or rates of tax. What these guaranteed insurability options do, across providers, not just with ourselves, is they allow the client to increase the amount they’re covered for at certain trigger events free of underwriting. That’s really the key. Different providers have different restrictions on the amount that they can increase by, and the age at which those events and that flexibility can be utilised.
So with Protect, our product for example, we have the ability to increase the sum assured by up to £250,000 if it’s a change in liability for example that’s happened, as in this case. Alternatively we have a situation whereby if actually the rates of tax were to change, again we can look up to the amount of the sum assured, so £250,000 in this case, or up to £5m. So there is a huge amount of scope. And again those options can be exercised up until the client is 91. So we’re not trying to cut them off at the knees, we’re really making sure that as they get older, as their needs change, that flexibility lasts with them.
In terms of Aunt Maud specifically, what we’re seeing is that £300,000 flooding into the estate is going to have a natural impact on their liability. So what we see is that we see it changing from £250,000 to £370,000. So we need that increase to be at least £120,000. Now both those GIOs, those guaranteed insurability options, would accommodate that increase. And they would allow the couple to increase by £120,000. It wouldn’t need to be underwritten, and it would mean the whole of their liability was covered, take into account the increase that the inheritance tax has had on the estate value.
PRESENTER: In that case talk us through how that works then, how to protect against a future increase in estate value.
NATHALIE CLAEYS: Well exercising the GIOs is one of the main ways of doing it. So that would simply be a case of approaching the provider, demonstrating the evidence needed, as in this case demonstrating the payment hitting the estate. And the calculation subsequently that the insurance, the liability has increased. Again we go back to the calculator, which is taking a look, and again it will do that for you. So suddenly the inheritance tax becomes one of your additional assets, and you can see through the slide the impact it has on your total assets. In this case the client’s liabilities unfortunately haven’t changed, there’s still the credit cards at £10,000, and as a result we see that £370,000, that new liability: £250,000 having already been insured because they’ve taken the whole of life cover out and now the £120,000 being needed. So the provider will look at the calculation, they’ll be in a position then to increase the sum assured, no underwriting at all. The client’s happy, they’re well within their limits as long as they look to do that before they’re 91.
PRESENTER: So there’s no problems with having to go for health checks and so on and so forth.
NATHALIE CLAEYS: No, the beauty is to allow them the flexibility to increase within certain limits without making them go through that again.
PRESENTER: This next slide then actually talks us through the steps, the process you go through in order to protect against future increases in estate value. Walk us through that.
NATHALIE CLAEYS: Absolutely, what we’re looking to do always is make sure that we allow the client to make the changes ideally without having any type of additional underwriting journey. That’s always our first point of call. You can see the two in front of you, so where there’s an increase in estate value I’ve mentioned about that being one of the triggers, and also the change in inheritance rates or the tax bands. So those two triggers will allow the GIOs to come into effect. Those as I said are relatively standard practice for insurance providers. One area which is often overlooked, but particularly with our contracts is quite important, is our permanent inflation option, our PIO if you were.
Now an inflation option, or an indexation option as it’s also called, is not a unique feature to our contract with Protect. Generally it applies to just about every contract out there in terms of protection. Most providers will increase the sum assured, the option every year, generally by the retail price index. But what tends to happen is if a client declines the offer once or twice or three times, they tend to lose that ability in the future. So where our advisers are finding our features are that little bit more flexible is our PIO, our permanent inflation option, is actually permanent. So it’s contractual, it’s offered on all of our contracts, and it gives the client the ability every year to decide would they like the increase.
Now it’s based on the retail price index as a percentage, but it will always be a minimum of 5%. And it doesn’t actually matter how many times a client says no to it, they’ll still get that opportunity to say yes every single year. So where our advisers are using this is this opportunity for regular review, and I believe when you mentioned earlier how important it is to have that ongoing conversation with the client about this area. It allows the adviser to go back in, reassess if there’s been any change to the liability, is there any more insurance required? And then make a decision as to whether they accept the increase or not. The good news is it doesn’t matter how many times they say no to it. And that becomes particularly effective if as we get older for example, they’ve exhausted the amount they can have on the guaranteed insurability options, and they want the ability to be able to steadily increase the amount they’re insured for, again without underwriting.
PRESENTER: Right, so that’s protecting against the future increase in estate value, changes in inheritance tax rates and tax bands – the politicians may have something to say about that – and therefore there is almost an innate desire for people to have flexibility in these instances.
NATHALIE CLAEYS: I think so. The nature of these types of contracts by definition should last for the whole of a client’s life. And the one thing that we see time and time again with clients in terms of our economy changing, political decisions changing, our environment is that we need that ability to future proof. And our wealth managers, specifically as an IFA group, are very aware of how important it is to make sure those policy solutions keep working for the clients. Now as I said to you the GIOs are not unique to Old Mutual Wealth. And again you should be looking at those to make sure that you are giving the client as much flexibility to make those changes in the future. But there are some unique selling points to some of the other providers that again advisers should be utilising if it’s necessary.
PRESENTER: Two areas that confront people as they get older. One is the idea, the concept of downsizing. Many people from my generation in particular see their house as their ability to fund their retirement as it were, and therefore they will sell the house, they will accrue the capital sum, invest it and take their pension income from that, so a comment or two about that. And the other area is if they fall into ill health and there’s a requirement for long-term care. What have you got in your toolbox for those circumstances where this is concerned?
NATHALIE CLAEYS: You are absolutely right. Changes in circumstances don’t just require an increase in sum assured. The whole point is keeping that flexibility to accommodate an active mitigation strategy. And a change of lifestyle, so downsizing would be one of them. And we are constantly hoping that the client continues working with the adviser to drive the taxable estate value down. As I mentioned earlier no insurance provider is going to have a problem if you reduce your sum assured. It is a permanent move that you make, obviously you can’t look at increasing it again essentially unless you’re looking at re-underwriting. So there’s no problem if you want to reduce the value that you’re insured for. Whether you do that across any contract that you take for protection, or whether you choose to do that at one of the rollover points on the rolling term.
So decreasing the protection and the subsequent premium is fantastic. But it is a permanent solution. If a client is worried about costs upfront, as you mentioned earlier, or for example they recognise that part of their commitment and ongoing relationship with their adviser is active IHT mitigation, they could be sitting there thinking well I don’t really want to pay £237 because I won’t need £250,000 worth of cover in 10 or 15 years’ time. I’ll only need half that. So again the rolling term or the stepped whole of life means you’re paying upfront, certainly for the first 20 years, a much lower premium. So any conversation about taking a contract like that where the premiums will increase in the future has to go hand-in-hand with a very honest conversation with the client about how they plan to reduce their sum assured.
So there has to be a commitment from the client to do something during that 20-year period that is going to make sure that in the future we drive down the liability. You can then drag down the actual amount the client’s covered for and bring the premium down accordingly. So we’re not seeing that client paying £1,400 a month in some future point in time.
PRESENTER: What about long-term care provision?
NATHALIE CLAEYS: That’s a real difficult one to be honest with you. And unfortunately while the industry as a whole is trying to raise awareness of the importance of advisers in dealing with it, clients are still reluctant to really accommodate the need to finance long-term care in the future.
PRESENTER: Confront it in fact.
NATHALIE CLAEYS: Absolutely. We introduced something called the Disability Conversation Option. So if you think about a situation, for example this client where they have £250,000 worth of life cover, they don’t need as much. Bob and Thelma don’t need as much in the future. They’ve worked with their adviser. But they recognise actually Bob has been unwell, we might need to turn this life cover into a more flexible solution. So Disability Conversion Option allows them to take some or all of that life cover and convert it into a monthly disability payment. So you change the use of it. It doesn’t change the overall premium, they don’t have to be re-underwritten, but it means they also don’t have to die to access some of that money.
So every £10,000 worth of life cover converts into a £200 monthly benefit. They can convert up to £150,000, and if they are unable to satisfy the activities of daily living it will pay out for up to 50 months for them. And it can go some way towards accommodating a need to move into maybe some type of social or residential care.
PRESENTER: That goes some way to the criticism that people have about using life insurance policies in these circumstances, that they lose control over that money. They’re paying away and therefore they have no control. So this brings back an element of control into it.
NATHALIE CLAEYS: Absolutely, particularly as you raised earlier that investment clients want to be able to see that money, because potentially if they have a long-term care need they could access that money, and they could achieve, could use that to fund the cost of the care they’re going to receive. Hopefully this conversion option as you said allows them to accommodate the same but not sacrifice the actual net return they’d achieve by keeping it in a whole of life contract effectively.
PRESENTER: Right, then just review for us briefly what this ideal solution should look like. We’ve got it on the slide.
NATHALIE CLAEYS: In terms of an ideal solution, traditionally and still the bedrock product will be a guaranteed whole of life contract, and for this particular married couple we want it set up on a joint life last death basis. Now the reality is if a client is concerned about cost, or they have in mind an active mitigation strategy, then by all means utilise the stepped whole of life or rolling term contract. Make sure the client is aware of the breadth of protection solution that’s available. So whole of life set up on a joint life second death basis. Please, please, please make sure that you have a corresponding trust conversation alongside the protection conversation, because it’s so important that what you’re not doing is making that client’s situation worse by having a big lump sum of money flooding into their estate at the wrong time, which actually makes their liability much more than you actually anticipated.
This is an ongoing conversation. Take the opportunity to ask the client to commit to those regular reviews. Whether you’re utilising our permanent inflation option to achieve that, or whether you’re just asking the client to commit to that regular review of their liability and their assets and liabilities changing in the future. It’s so important the client recognises an affordable solution. Not just in terms of the current affordability, but long term. And again it could be that the rolling term is one way of satisfying or reassuring them about the affordability aspect of it, or be open to exploring different funding solutions. Look at whether or not the client has the ability to derive income from investments that they might have already. Recognise that the beauty of our pension reform now is such that we have this ability to draw from our pension fund that again could be utilised to fund it.
So again short as well as long term affordability is important and worse case you’ve always got the kids that you could call upon because ultimately they’re going to benefit from it. And finally…
PRESENTER: And finally flexibility.
NATHALIE CLAEYS: Absolutely, recognise I guess that there are solutions out there from providers that challenge the norm and the expectation. You should expect a policy that you’re recommending to work with your client in the future. You should expect as a minimum it has the ability to increase without underwriting subject to limits, as well as be flexible enough to decrease. Or even change what’s insured if that’s what the client needs. So I guess the final thing I’d end with is don’t be afraid to really challenge what you need, and ask providers to demonstrate to you what makes their provisions exceptional, what makes them different, what makes them unique. And recognise that you really should be looking for the best of those to give your clients the best chance of accommodating those changes in as least intrusive an underwriting way as possible.
PRESENTER: On that note Nathalie Claeys, thank you very much indeed.
NATHALIE CLAEYS: Thank you for your time.
PRESENTER: Stay with us and we’ll review the learning outcomes.
Here’s a reminder of the Akademia learning outcomes. In order to consider the viewing of this video as structured learning, you must complete a reflective statement to demonstrate what you’ve learned and its relevance to you. By the end of this session you’ll be able to understand and describe the current inheritance tax thresholds, the recent significant change, the family home allowance; what advisers can do to help clients not to fall into the inheritance tax trap; how the use of regular premium solutions may help to fund the IHT bill; when is an appropriate point in discussions with clients to talk about IHT planning; how to help them mitigate their exposure to potential IHT liabilities; using whole of life and whole of life contracts, rolling term protection contracts, guaranteed insurability options, downsizing and changes in client circumstances.
Please now complete the reflective statement in order to validate your CPD. And don’t forget to watch out for the other Akademia learning modules.