IHTM20553 - Split or Retained Interest Trusts: single lump sum investments: further details

There are two approaches to identifying the amount of the retained portion. It can either be a specified monetary amount or a specified percentage of the fund. The different approaches affect how the value of the retained fund is calculated after any withdrawals are taken and therefore the value of the retained fund on death. Where a retained percentage is used, the settlor’s fund can increase as the value of the underlying bond increases, whereas with a fixed monetary amount all of the increase in value of the bond accrues to the beneficiaries’ fund.

Example of a retained monetary amount

Alicia transfers £250,000 into a split trust arrangement. She sets her retained portion at £100,000 and therefore makes a transfer of value of £150,000 (the difference between the £250,000 invested and the £100,000 retained portion).

Alicia receives a withdrawal payment of £12,500 at the end of the first year. Alicia’s retained fund is now £87,500 (the original £100,000 less the £12,500 received).

Alicia receives two further payments of £12,500 in subsequent years and then dies. On her death Alicia’s retained fund is valued at £62,500 (the original £100,000 less three payments of £12,500). This £62,500 retained fund is part of Alicia’s estate for inheritance tax purposes.

If Alicia does not take any withdrawals in her lifetime her interest will remain at £100,000. This is different if the retained portion is expressed as a percentage of the fund.

Example of a retained percentage

Darius transfers £500,000 into a split trust arrangement. He sets his retained percentage at 50%. He therefore makes a transfer of value of £250,000 at that time.

Each time Darius take a withdrawal from the fund, this reduces his retained interest. The calculation of this reduction can be quite complicated but this will be done by the insurance company, for example:

Darius takes a withdrawal of £10,000 at a time when the fund has increased from £500,000 to £510,000. Darius’s interest in the fund before he takes the withdrawal is 50% of £510,000, or £255,000. Once Darius withdraws £10,000, the total fund is now worth £500,000. Darius’s interest in the fund is now £245,000 (his interest at the time of withdrawal of £255,000, less the withdrawal of £10,000) out of £500,000, or 49%.

Darius dies 9 years after setting up the arrangement. At that time the bond is valued at £650,000 and Darius’s interest is 32.5%. The value of Darius’s retained fund at his date of death is £211,250.

If Darius had taken no withdrawals in his lifetime his retained interest would have remained at 50% at his date of death. If the bond was worth £650,000 at the date of death the value of Darius’s retained fund would be £325,000.