Life insurance in trust (avoid or minimise 40% inheritance tax in 2024)

What is life insurance?

Life insurance simply provides a financial safety net for your dependents should you no longer be around to provide.

You calculate your required cover amount (known as the sum assured), you determine the length of the policy (the term) and then you pay a monthly premium to receive the cover.

Life insurance is often taken out after one starts a family, buys their first property, or gets married.

The proceeds from a policy are commonly used to cover mortgage repayments, future family living costs, rising funeral expenses, and/or to provide an inheritance.

Inheritance tax (IHT)

The proceeds paid out from a life insurance policy by default form part of your estate and are therefore subject to inheritance tax here in the UK.

At the time of writing this article, the IHT threshold is £325,000. Therefore, you will not have to pay any tax until you exceed this figure. However, anything over and above this threshold is taxable at a significant 40%.

The total value of your estate is made up of any property in your name, any savings/assets, as well as your life insurance, and therefore for many in the UK it will be easy to exceed the £325,000 threshold.

However, there is a way of ensuring that your life insurance payout avoids forming part of your legal estate and therefore is not subject to IHT.

What’s more, it is completely free to implement. Despite this insurer Aegon suggests that a mere 6% of policyholders utilise this option.

Writing your life insurance in trust

As mentioned, by writing your life insurance in trust the proceeds are detached from your estate and not subject to IHT.

You sign the rights to your policy over to a trustee/s to administer on your behalf, like the executor of a Will. As a result, you must choose a trustee/s whom you implicitly trust to carry out your wishes.

Writing your life insurance in trust can also result in your dependents receiving the funds much faster.

Because the proceeds do not form part of your estate, loved ones do not have to wait for probate to be granted before funds can be released. Probate often takes between 6 – 9 months however can be much longer if complications arise.

Finally writing your life insurance in trust can allow greater control of how and when a payout is distributed.

For example, in a scenario where your children are very young when a claim is made, you could specify within the trust that you only want them to receive the funds after they have reached adulthood.

The Different Types of Trusts

There are 3 common types of trust, and you must choose the correct trust to meet your specific needs, otherwise, there could be negative repercussions.

For example, with an Absolute trust (see below) you name the beneficiaries when setting up the trust however your decisions cannot be changed at a later date.

This poses a significant problem if you go through a divorce and then perhaps remarry/extend the family further.

The 3 trust options commonly offered by all major life insurance providers include;

Absolute trusts (or Fixed trusts)

• Name the beneficiaries
• Determine how the payout is distributed between beneficiaries
• Cannot be changed

Discretionary trusts

• Most flexible trust
• No named default beneficiaries
• You provide a list of potential beneficiaries but the trustee/s are given total discretion as to who will benefit, when, and by how much
• You can send a letter of wishes detailing how you would like the funds to be distributed, however, there is no legal obligation for the trustee/s to adhere to your wishes

Flexible trusts

• Name the default beneficiaries
• You can also name potential beneficiaries (i.e. future grandchildren)
• Trustee/s can change the default beneficiaries
• Trustees can change the payout split between default and potential beneficiaries to meet their wishes
• Could be a good option if you think circumstances may change in the future

Learn more about discretionary trusts – Discretionary Trusts in Divorce – Can It Protect My Assets?

Information on Trustees

It is a legal requirement for a trustee to be over 18 years old and they must have a valid UK bank account. A trustee can also be a beneficiary, and this is common within family trusts.

Often, a policyholder will name their spouse or children as trustee/s. Where trustees are gifted discretionary rights, it may be advisable for there to be an independent trustee who would not benefit from the trust, such as a solicitor.

After you have passed, the proceeds from the life insurance policy are paid to the trustee/s to carry out your wishes.

Conclusion

Arranging life insurance is a selfless act and one which many parents carry out to ensure their loved ones are financially secure whatever the future may hold. As a result, it is imperative to maximise a future payout and make the most of your investment.

Whilst writing your life insurance in trust will not be suitable for everyone as detailed above it can provide significant benefits. However, it may be beneficial to seek independent financial advice, especially if your situation is more complex.

Please note, that this article should not be considered as financial advice but as a guide detailing your available options.

All major insurers in the UK allow you to write your policy in trust, usually free of charge, although not all providers will offer all the trust options.

If you require additional support leading insurance broker Reassured has a dedicated in-house trust writing service which they offer free of charge to customers purchasing a policy through them.