Regular premiums up to £6,000 a year will be exempt for IHT purposes, as long as the clients have not used their annual allowance elsewhere.

Where premiums exceed this, or they have used their allowances elsewhere, the exemption of normal expenditure out of income may be available provided that the payments are regular, do not affect the clients' standard of living, and are out of natural income.

Where the policy is written on a joint life last death basis, the sum assured is payable on the second death and, subject to an appropriate trust being used, will be outside the estate for IHT purposes.

As there are two Settlors to this type of arrangement, for tax purposes the trust will be treated as consisting of two settlements (one from each person = £325,000 per person for tax year 2010/11) and benefit from two nil-rate bands (NRB) at future dates (eg 10-yearly periodic charge, see below).

At entry, premiums may be exempt and, if not exempt, the normal expenditure out of income exemption may be available. If not, any gifts would be chargeable lifetime transfers (CLTs). If the amount of the CLTs plus any CLTs in the last seven years is less than the current NRB (£325,000 for 2010/11), then there will be no immediate tax to pay on this CLT but it will reduce the NRB available for the next seven years.

The trust will also be subject to exit and 10-yearly periodic charges. If the clients were to die in the first 10 years, there would be no tax to pay under this scenario when the trustees distributed the Trust Fund (as long as this was before the 10-yearly periodic charge).

Assuming both clients are alive after 10 years, the basis of the 10-yearly periodic charge is the greater of the market value and the premiums paid (assuming a whole life type of product). This value would then be added to any previous CLTs and available NRB to work out what tax, if any, was due.

If we assume the clients are in good health and have a normal life expectancy at the 10-yearly periodic charge, the trust value is likely to be based on the premiums paid. Assuming no other CLTs are created before the trust is established, the value would be £60,000. Assuming that the NRB is higher in 10 years time than the current £325,000 it is likely that there would be a nil 10-yearly charge.

However, if we assume one life assured has died and the other is in poor health, the maximum the trust value could be is equal to the sum assured, £436,000. This is again likely to be below the two NRBs, which are available as the Trust has two Settlors, and may result in no tax at this point. The exit charges are calculated on the effective rates established at entry and future 10-yearly periodic reviews. This would mean the sum assured, on the death of the remaining life assured, could be distributed by the trustees without any exit charge provided it was paid prior to the next 10-yearly anniversary.

If the life assured died at the end of year 11 and the Trust Fund were distributed, the exit charge on £400,000 would be:

£4,500 (6% of Trust Fund value) divided by £400,000 multiplied by number of complete quarters since the last periodic charge (4) divided by 40 = £450
Total tax paid by trust is £4,500 + £450 = £4,950
Overall effective tax rate 1.2375% of £400,000

This demonstrates that the tax changes are real but can have a minimal impact on this type of planning. Scenario 2, where tax is payable, is designed to show that, even where tax may be due, there are many factors which need to work against the client for tax to be due, plus the actual tax payable is significantly less than expected.

For significantly larger sums assured, creating a series of trusts on different days with a smaller policy in each of them (eg £1 million sum assured split into four policies of £250,000) will add additional flexibility and enable each trust to establish its NRB for the purposes of the 10-yearly periodic charge. This is currently known as the Rysaffe principle. In this scenario, each trust has its own NRB so future exit and 10-yearly periodic charges will generally be reduced.

For the purposes of the entry charge, the Settlor will still only have one NRB and any CLTs made will reduce the Settlor’s NRB for seven years from the date they are made. Product pricing and additional reporting requirements must also be considered.