What is a Back-to-Back Plan?
A Back-to-Back Plan is an estate planning arrangement for individuals who need income from their capital but also wish to preserve wealth for their beneficiaries and reduce their Inheritance Tax (IHT) liability.
It combines a Purchased Life Annuity (PLA) with a Whole of Life (WOL) insurance policy written in trust.
How Does It Work?
Capital is used to purchase a PLA, providing a guaranteed income. Part of this income funds the WOL premiums, with the balance available to spend.
- Single-life PLA: Income ceases on death, with the WOL policy paying out on the annuitant’s death.
- Joint-life PLA: Income continues to the surviving spouse or civil partner, with the WOL policy arranged on a second-death basis.
The WOL policy should be written in an appropriate trust, allowing the proceeds to pass directly to beneficiaries outside the estate. The sum assured should equal the original capital used to purchase the PLA, replacing that capital on death.
Purchased Life Annuity (PLA)
A PLA is purchased using personal capital rather than pension funds and provides a guaranteed income, which can be level or escalating.
The income payable depends on:
- Age and health: Older individuals and those with reduced life expectancy can receive higher annuity rates.
- Purchase price: More capital provides a higher income.
- Gilt yields: Higher yields typically increase annuity rates.
- Options: Escalation, joint-life benefits and guarantees reduce the starting income.
Tax treatment: Each annuity payment comprises a tax-free return of capital and a taxable income element, subject to Income Tax.
Inheritance Tax Considerations
The WOL policy is written in trust to keep the death benefit outside the estate.
Premiums can qualify for the normal expenditure out of income exemption where they are regular, paid from income and leave sufficient income to maintain the individual’s usual standard of living. The £3,000 annual gift exemption may also be available.
Important: Special IHT anti-avoidance rules apply to associated annuity and life assurance arrangements. Correct structuring is essential.
Suitable for individuals who:
- Need a secure income from their capital.
- Wish to replace capital for their beneficiaries on death.
- Have a potential IHT liability.
- Can afford the insurance premiums and do not need access to the original capital.
Disadvantages:
- Capital committed to the annuity cannot be withdrawn.
- WOL premiums can be expensive, particularly with age or poor health.
- Level annuity income loses purchasing power through inflation.
- Early death can result in limited annuity income received.
- Incorrect structuring can affect the intended IHT benefits.
Summary
A Back-to-Back Plan combines guaranteed income with life assurance to provide a lump sum for beneficiaries while potentially reducing IHT. Suitability depends on income needs, age, health and estate planning objectives.
Disclaimer: This information is provided by Clarity Financial Training Ltd for educational and study purposes only, to support students undertaking financial services qualifications. It is not intended as personal financial, investment or tax advice and should not be relied upon when making financial decisions. Individuals requiring advice should consult an appropriately qualified financial adviser.
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