How do life insurance trusts work?
Key takeaways
Life insurance offers loved ones a financial safety net in the event of your death by providing an emergency cash fund to pay the mortgage and cover daily expenses. This can help prevent the forced sale of the family home
If life insurance is not written ‘in trust’ the payout forms part of the deceased’s estate and will be included in the inheritance tax (IHT) calculation, so could be subject to 40% 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 life insurance policies written in trust are intended to be irrevocable and cannot be easily changed once established, so it’s important to choose trustees and beneficiaries very carefully
Should I put my life insurance policy in trust?
Yes, it is usually recommended to put your life insurance policy in trust. Life insurance is more than just a financial product; it's about ensuring that even when you’re no longer around your loved ones are financially secure. It allows them to remain in their home, and to avoid monetary hardships. By placing your life insurance policy ‘in trust’ you can protect it from inheritance tax. This means the full value of the policy does the job it was designed to do, rather than a portion of it disappearing in tax.
What is a trust when it comes to life insurance?
A trust is a legal agreement which you can set up through your life insurance provider. It ring-fences your life insurance payout, meaning it is outside your estate for inheritance tax purposes.
Without a trust, the payout from your life insurance may be included in your estate for inheritance tax purposes and if your total estate exceeds £325,000 (known as the ‘nil-rate band’), the value above this may be taxed at 40%.
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. Writing life insurance ‘in trust’ ensures the payout goes directly to the surviving partner, without complications from estate claims. This can be a significant issue for those not married or in a civil partnership. Probate delays can be avoided.
Can all types of life insurance be placed in a trust?
When it comes to life insurance, there are several different types to choose from, and any of them can be placed ‘in trust.’
Types of life insurance
Term life insurance
This is the most common type and only pays out if you pass away within the specified term of the policy. This could, for example, be the time it takes for your children to become financially independent or the duration of your mortgage. If you die within this period, term life insurance pays out a set amount of money.
Decreasing term life insurance
This is the most common form of ‘term’ cover and is typically taken out to cover a repayment mortgage. 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.
Increasing term life insurance
With this type of ‘term’ policy, the sum insured goes up each year by a fixed amount for the duration of the policy, ensuring it keeps pace with inflation. Increasing term life insurance may be more costly than other types of cover.
Level term life insurance
With this type of ‘term’ cover, the payout remains the same throughout, making it suitable for interest-only mortgages.
Whole-of-life insurance
Unlike term life insurance, this type of policy comes with the assurance that no matter when you pass away, there will be a payout. This type of insurance is often intertwined with estate planning. Policies can be used to offset inheritance tax payments.
Over 50s life insurance
Tailored for those over 50. There are no medical questions for this type of 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 end up paying out.
A joint life insurance policy is a practical solution for couples, typically paying out upon the first death and ending after the first claim, ensuring the surviving partner receives the support when it is most needed.
How do I set up a life insurance trust?
It is usually relatively straightforward to get your life insurance policy ‘written into trust.’
This can be arranged with your insurance company at the point of purchasing your policy. Insurance companies will provide the trust forms and guidance free of charge.
You will need to specify details about the trustees – these are the individuals who will manage the trust. It’s important to choose trustworthy friends or family members who will act in your best interests. They need to understand their responsibilities. As trusts are intended to be irrevocable, they cannot easily be changed once they’ve been set up.
You will also need to give your insurance provider details of the beneficiaries – these are the people who will receive the payout.
What are the different types of life insurance trusts?
These are the three main types of trust you could set up:
Types of trusts
Discretionary trusts
Offer flexibility in how benefits are distributed among beneficiaries
Absolute trusts
Fix the beneficiaries from the outset, with no changes allowed
Split trusts
Are suitable for policies that cover both life and critical illness, ensuring that benefits are allocated appropriately
What are the advantages of life insurance trusts?
There are a number of benefits or getting your life insurance policy written in trust:
Potential avoidance of inheritance tax – as the payout is usually kept outside your estate
Faster distribution of the payout – funds are paid directly to trustees as opposed to having to go through probate
Assurance that the intended recipients receive the money
What are the disadvantages of setting up a life insurance trust?
There are, however, certain considerations to keep in mind:
Trusts are intended to be irrevocable, so it’s important to be certain of your decisions at the outset
Trustees hold significant control over the policy, including how and when proceeds are distributed to beneficiaries
Trusts can last for up to 125 years, but they are usually wound up once they’ve served their purpose and the payout has been distributed
How can I find the right life insurance policy for me?
MoneySuperMarket compares lots of different life insurance policies in minutes, including over 50s life insurance, level term insurance and decreasing term policies. We can help you find the best cover for your circumstances quickly and easily, saving you both time and money.
Author
Esther Shaw
Money expert
Esther Shaw is an award-winning consumer, financial and property journalist with more than two decades of experience. As a freelance writer, she regularly contributes to a range of national titles...
Reviewer
Beth Leslie
Senior Insurance Content Editor
Beth is an experienced writer and editor who specialises in financial and economic content. She is currently the Senior Insurance Content Editor for MoneySuperMarket. Beth is passionate about making...
