How trusts work when it comes to life insurance
Life insurance provides your loved ones with a lump sum of money if you die unexpectedly, which they can use to put towards things like mortgage payments. But unless you put the policy in trust, it may be subject to inheritance tax, of 40%, when you die.
Key takeaways
Life insurance ensures financial security for your loved ones, allows them to remain in their home, and can help to avoid monetary hardships
Without a trust, life insurance payouts could be subject to a 40% inheritance tax if the estate exceeds £325,000
It’s usually free to place a life insurance policy in trust and this can be done at any time, not just when you buy a policy
Be aware that trusts are irrevocable and trustees hold significant control over the policy so decisions must be certain
Life insurance is more than just a financial product; it's about ensuring that even in your absence, your loved ones are financially secure.
If you place a life insurance policy in trust, this also means you can protect it from inheritance tax.
What is a trust when it comes to life insurance?
A trust is a formal agreement which you can set up through your life insurance provider. It ring-fences your life insurance payout and protects it from inheritance tax (IHT).
Without a trust, the payout from your life insurance could be subject to a 40% inheritance tax bill if your estate exceeds £325,000.
By placing your policy in a trust, you can exclude the payout from your estate's valuation for tax purposes, safeguarding more of your legacy for your beneficiaries.
For cohabiting partners, trusts are particularly important. They ensure that the surviving partner receives the payout without complications from estate claims, which can be a significant issue for those not married or in a civil partnership.
Understanding life insurance types
When it comes to life insurance, there are several different types to choose from, and any of them can be placed in trust:
A level term life insurance policy a financial safety net that spans a specific period. This could be the time it takes for your children to become financially independent or the duration of your mortgage payments, for example. If you were to pass away within this term, term insurance pays out a set amount of money.
If you want to take out a life insurance product to cover your mortgage, a decreasing term policy is usually your best bet. The amount paid out decreases over time, mirroring your mortgage balance.
This is usually the cheapest type of life insurance to buy, as the payout is designed to just cover a mortgage balance – not for other expenses.
Whole-of-life insurance is the assurance that no matter when you pass away, there will be a payout. This type of insurance is often intertwined with estate planning or considered an investment strategy and may be subject to taxation in certain circumstances.
Over 50s life insurance is tailored for those over 50. There are no medical questions for this life insurance policy, making it a good option for individuals with pre-existing health conditions.
It does, however, typically include a waiting period before claims can be made and because of its high monthly premiums, there is a risk that you can pay more into your policy than it will pay out.
A joint life insurance policy is a practical solution for couples, paying out upon the first death and ending after the first claim, ensuring the surviving partner receives the support they need.
Types of life insurance
Level term life insurance
Decreasing term life insurance
Whole-of-life insurance
Over 50s life insurance
Joint life insurance
How to set up a trust
It is usually simple and straightforward to set up a trust for your insurance policy.
Insurance companies often provide assistance in establishing a trust alongside the purchase of life insurance. This involves specifying details about the trustees—who will manage the trust—and the beneficiaries—who will receive the payout.
In a trust, the settlor is you, the policy owner. The trustees are the individuals you appoint to manage the trust, and they must be chosen with care as they will outlive the settlor and manage the trust according to the trust deed, which is irrevocable.
The beneficiaries are those who will receive the payout upon your death.
Types of trusts
These are the three main types of trust you could set up:
Offer flexibility in how benefits are distributed among beneficiaries
Fix the beneficiaries from the outset, with no changes allowed
Are suitable for policies that cover both life and critical illness, ensuring that benefits are allocated appropriately
Types of trusts
Discretionary trusts
Absolute trusts
Split trusts
The advantages of trusts
The benefits of writing your life insurance policy in trust are substantial:
Avoidance of inheritance tax
Quicker distribution of the payout
Assurance that the intended recipients receive the money
Disadvantages of setting up a trust
However, there are considerations to keep in mind:
Trusts are irrevocable, so be certain of your decisions.
Trustees hold significant control over the policy.
Trusts can last for up to 125 years, but they typically exist as long as necessary for your personal circumstances.
Finding the right life insurance
MoneySuperMarket compares lots of different life insurance policies in minutes, including over 50s life insurance, level term insurance and decreasing term policies, to help you find the best cover for your circumstances.
