Life insurance and ‘trusts’

What is a ‘trust’

If you have taken out life insurance to provide for your family after your death, the money could be subject to inheritance tax (IHT) as it will form part of your estate when you die. 

For this reason, it’s probably a good idea to place the policy ‘in trust’. 

With your policy written ‘in trust’ your loved ones can then legally sidestep IHT and will not have to give any of the proceeds of the policy to the taxman. 

Putting a policy in trust can also help your beneficiaries avoid probate. This means they can get hold of the life insurance payout without a lengthy legal process. 

How do trusts work?

A trust is simply a legal arrangement that allows you – known as the settlor – to bequeath your life insurance to someone else, known as the beneficiary. 

The settlor also appoints trustees who take legal ownership of the trust and look after the deeds which govern it. They are duty bound to act in the interest of the beneficiaries at all times. 

There is usually a minimum of three trustees who must all be aged 18 or over. If you want to change a trustee, all the other must agree. 

It is the responsibility of the settlor to pay the premiums for the life policy, even when it is in trust. The settlor is also usually a trustee, so has some control of the management of the trust. 

Trust benefits

If a life policy is not placed in trust it is usually considered part of your estate when you die. Your loved ones could therefore be liable for IHT on the proceeds. 

The current rate of IHT is 40% of your estate above the nil rate band of £325,000, so it could take a big bite out of their inheritance. 

So in simple terms, a life insurance pay-out of £600,000 would therefore attract 40% tax on £275,000 (£600,000 - £325,000). That would be a tax bill of £110,000, reducing the pay-out to £490,000.

By placing your life policy in trust, it will not form part of your estate so should not be subject to IHT. In other words, your beneficiaries will receive all of the money. 

A trust also allows you to decide who will get the money from your life insurance – and even how it is spent. For example, you might insist that any proceeds are used to fund your children’s education. 

The third advantage of a trust is that it usually means the money is paid quickly to the beneficiaries, because they do not have to wait for a grant of probate.  

However, it’s important to remember that you are handing over control of the trust, all or in part, to the trustees. Also, once a policy is put into trust it is almost impossible to cancel the arrangement.

A trust also allows you to decide who will get the money from your life insurance – and even how it is spent.

How do I set up a trust?

Most life insurance policies can be placed in trust, and it’s a fairly straightforward process. Your insurance company will normally supply the relevant forms free of charge. 

They should be offered to you when you apply for your policy, or you should be given a clear indication that the trust option is available. Don’t hesitate to ask for the forms if necessary.

When can I put an existing policy into trust?

You can put your policy in trust at any time, so it doesn’t matter if you took out the life insurance yesterday, last year or several years ago. 

Types of trust

There are various different types of trust – and the best one depends on your personal circumstances. 

A discretionary trust, for example, is a flexible arrangement that allows you to add beneficiaries and give guidance to trustees in a letter of wishes. 

An absolute trust is more rigid because the beneficiaries cannot be changed. 

The different types of trust can be treated differently for IHT purposes. The trust might also pay tax itself. It is therefore important to seek expert legal advice if you are thinking of placing your life policy in trust.

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