What is the Rysaffe Principle and how does it save UK inheritance tax?

The Rysaffe principle can offer significant advantages for inheritance tax (IHT) planning, and here’s how it can bring substantial benefits to clients.

Over the years, various Chancellors have made changes to the inheritance tax (IHT) landscape, from altering non-domicile rules to freezing nil-rate bands until 2028. Consequently, IHT remains a contentious tax, with the 2022/23 fiscal year witnessing a remarkable £1 billion increase, pushing the total to an all-time high of £7.1 billion. Projections even suggest it may reach £8.3 billion by 2026/27, or possibly earlier. Notably, the number of estates subject to IHT has doubled since 2019, with an average bill exceeding £216,000.

While there are numerous IHT planning strategies available, using whole-of-life (WOL) protection policies to create a lump sum upon the client’s demise for covering IHT has gained popularity. This approach allows clients to retain access and control over their wealth while paying a guaranteed monthly premium. Importantly, these policies must be placed in trust to avoid inclusion in the estate.

Discretionary Trusts have been a favoured choice due to their flexibility in determining trust property beneficiaries. However, there was a time when Interest In Possession trusts and Accumulation and Maintenance trusts were commonly used due to their favourable tax treatment. This changed in 2006 when these trusts became subject to the relevant property regime, making Discretionary trusts more attractive. Nevertheless, these changes inadvertently affected life policies placed in trust due to their underlying trust structure.

In the ever-evolving landscape of IHT planning, there are still opportunities to enhance value for clients. One often overlooked method, while utilising a WOL policy within a discretionary trust, is the use of the Rysaffe principle.

The Rysaffe principle emerged in 2003 following the Rysaffe Trustee Co (CI) versus Inland Revenue Commissioners case. This case addressed legislation concerning the creation of trusts on consecutive days. The court’s decision clarified that trusts created by the same settlor on different days are not considered related settlements for IHT purposes. This allows clients to mitigate the impact of the 10-yearly periodic and exit charges, as each trust benefits from its own nil-rate band (NRB).

Some may associate this planning strategy primarily with investment purposes, as it was popular for large on/offshore life assurance bond planning. A decade ago, the Treasury contemplated changing this technique by proposing a single ‘settlement NRB,’ which would be distributed among all trusts of a settlor. Fortunately, this idea was abandoned in favour of an anti-avoidance rule targeting same-day additions, which did not affect the use of life assurance protection policies.

The Rysaffe principle remains relevant for life assurance policies, ensuring that the trust’s value does not exceed the NRB. While it might only apply to a small number of cases, often involving high-net-worth clients with substantial sum assureds/premiums, lower available NRBs, or younger clients, it remains a viable option.

Consider the example below, illustrating the benefits of the Rysaffe approach:

Original Approach (One Trust):

£5 million sum assured

£53,000 annual premium

Rysaffe Solution (Split into Five Trusts):

Five policies, each with a £1 million sum assured

Set up on five different dates

Each policy has an annual premium of approximately £10,600

After 10 years, the total premiums paid would be £530,000. Therefore, a 6% periodic charge would apply on the excess over the NRB (£205,000 x 6%). It would take almost 31 years for each trust to exceed the current NRB. There would be a further charge of £44,100 after 20 years and £75,900 after 30 years. There would only be a periodic charge after 40 years, amounting to £5,940 on each trust.

The true benefit becomes evident when the client or life assured passes away, and the sum assured is paid into the trust for distribution to beneficiaries. If there was no periodic charge at the last 10-year anniversary, there would be no exit charge. However, if there was a periodic charge, it could be substantial. For instance, if the client died after 35 years, there would be an exit charge of approximately £120,000 without Rysaffe, compared to zero using the Rysaffe approach.

As a general guideline for deciding whether to use Rysaffe principle, divide the available NRB by the annual WOL premiums, taking into account any indexation. This will help determine how many years it would take for the premiums to exceed the NRB. If this, along with the client’s age, is less than their life expectancy, splitting policies can be a wise choice.

Most trusts holding pure protection policies are excluded from registering on HMRC’s Trust Registration Service. However, this can change when the trust faces a tax charge, such as a periodic charge, making the adoption of the Rysaffe principle even more compelling.

In summary, the Rysaffe principle remains a valuable tool for IHT planning using WOL policies.

If you need advice about setting up trusts, and other forms of inheritance tax planning like Rysaffe Principle then reach out here to a member of our team

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