Insurance-linked wealth management products have their attractive features but like all such things, users must understand the details. This publication spoke to some of the experts.

Editor's note: This article is part of an occasional series looking at how insurance is increasingly being used as a robust wealth protection tool in different parts of the world. As ever, reader feedback is most welcome.

In shielding wealth, the insurance route is getting paid more attention. But it is foolish to expect to circumvent rules against tax, people in the industry say.

With trusts under increasing regulatory pressure – as in the UK – financial advisors are looking at different structures to protect client money. Insurance products, such as private placement life insurance, are one such avenue.

At a recent conference in London, as reported by this publication (click here), delegates were told there was considerable growth potential from insurance-linked wealth products. The consultancy, Scorpio Partnership, meanwhile, has warned that the insurance-based wealth management market is missing untapped potential. It estimated that less than 5 per cent of all wealth management portfolios in emerging markets included an insurance component. If that share rose to 15 per cent in five years, this would create a market of almost $1.2 trillion.

The market has an established base in many Western nations, but there is more room for growth, industry figures say.

“The acquisition of insurance bonds is increasing in continental Europe; they have been popular  in the UK for a long time now,” Louise Somerset, tax director at RBC Wealth Management, told this publication recently.

But along with advice about their usefulness as products, came a warning from international law firm Baker & McKenzie about the limits of insurance-linked products.

"There has certainly been increasing interest in it [wealth-linked insurance products]. That interest should be based on the right reasons and where the insurance is appropriate for wealth management and succession purposes, and not to circumvent rules and hide undisclosed money,” said Lyubomir Georgiev, a member of the firm’s Europe & Middle East Wealth Management steering committee.

"It [insurance] has been used as a wealth planning tool for many years. It has become increasingly popular in the new world of increased tax transparency as tax planning becomes important for many clients,” Georgiev told this publication. "Life insurance, in contrast to trusts, is recognised in pretty much all jurisdictions where wealth owners generally reside."

“Due to the mobility of today’s wealth owners, where they may wish to relocate in the near future (for example, from the UK to Spain), there are increasing enquiries about insurance products that would qualify for tax benefits in more than one jurisdiction,” he continued.

“However, multi-jurisdictional products are harder to accomplish and keep current due to the differing tax systems in each jurisdiction that could change every year,” he said.

Different names

Insurance policies with a wealth management angle come in a variety of names. One potentially difficult issue is to understand the limits as well as benefits of policies known as “wrappers”. With some wrappers, the investments held in a policy are no different in structure from a mutual fund, in which case any tax mitigation benefits might be lost or reduced.

Georgiev said understanding the nuances surrounding the use of the “wrapper” term in the US and in other countries was vital. “A wrapper product will typically enable the client to retain a higher degree of control over the underlying investments and will often be funded with a single premium payment,” he said.

“However, such products would generally not qualify for tax benefits. In some jurisdictions, however, the term insurance wrapper may be synonymous with a more sophisticated private placement life insurance product, which is often intended to qualify for tax benefits available in the home jurisdiction,” he said.

To be generally tax compliant, an insurance policy must have features such as lack of investor control, underlying investment diversification, a level of death risk benefit that shows it is a genuine insurance policy and pooling of risks.

Non-doms

An area of increased interest in the UK, for instance, has been among non-domiciled residents in the country who are faced with a choice on whether, after having lived in the country for more than seven years, to pay the annual £30,000 (around $46,900) non-dom levy if they don’t want to pay tax on their worldwide assets - known as the “remittance basis”. (If they live in the UK for more than 12 years, the levy will be £50,000 from next April.)

Insurance bonds can help to decide that choice, said RBC Wealth Management’s Somerset.

There are specific advantages for non-doms if they hold their worldwide assets in an insurance product offshore. The tax deferred roll-up of income and gains combined with the ability to withdraw a maximum of 5 per cent per year results in less tax than paying the annual non-dom levy and this enables the non-dom to bring funds into the UK, she said.

Take this case: A non-dom has £1 million invested overseas which earns 5 per cent a year (£50,000). If the person does not want to pay any tax on his offshore income, he can pay £30,000, which is more than the tax (even at the 50 per cent top income tax rate) on the actual income, but he will not be able to spend it in the UK. So there is not much benefit to the non-dom in not paying tax on the non-dom levy.

On the other hand, a non-dom who has £10 million invested overseas, could earn £500,000 a year in income, and has more incentive to pay the levy.

However, for either taxpayer, an insurance bond is attractive, because capital gains/income earned by the worldwide assets held in the bond do not “arise” in the insurance product, so no annual levy has to be paid, said, pointing out that when the bond is eventually realised, any gains will be subject to income tax at the prevailing rate.

There are a range of established products in the UK, for instance, such as single premium assurance bonds. For example, a person puts a sum in a bond and up to 5 per cent  of the premium can be withdrawn tax-free a year for 20 years.

Definitions

Definitions are important, since if the insurance policy does not contain genuine “insurance” characteristics, the tax authorities will declare it invalid. Take the case of personal portfolio bonds, which are life insurance policies where the benefits payable are set by the value of property chosen directly or indirectly by the policyholder. These policies generally give rise a to a charge; policyholders are treated as having made a gain equivalent to 15 per cent of premiums paid.

Because of this, RBC’s Somerset says that to avoid these penal taxes, most life insurance bonds restrict investors’ control over assets and the like or alternatively only allow investment in "exempt assets", cash or funds. 

“If you set up a bond properly you can invest through the bond and enjoy growth in the value of the underlying investments without triggering any tax liability on income and gains that arise each year. You only get taxed to the extent that you take withdrawals over and above the 5 per cent [the withdrawal ceiling per year],” she said.

Is client interest growing for such products?

“Yes, people are interested in them [ insurance products] because they are in interested in not having to pay tax on an arising basis - particularly non-UK doms who can avoid both having to pay tax on the arising basis and having to pay the remittance charge in each year,” Somerset said.

As far as HMRC is concerned, a foreign insurance policy is usually issued by a company outside the UK although some domestic firms can issue these in its overseas life assurance business line.