If you're considering taking out a life insurance policy and your assets are growing in value, your loved ones are more likely to benefit from the payout in full if the policy is 'written in trust'.
You may only be thinking about covering the mortgage and other debts you don't want your family to have to pay in the event of your death. But a life insurance in trust can also ensure that your family get more of your money — instead of it going to the taxman as part of your inheritance tax bill.
Life insurance isn't usually subject to any tax - no income or capital gains. But - and it is a big but - depending on how much your 'estate' is valued upon your death, that life insurance pay out could be subjected to a large inheritance tax bill instead of it being received in full by your loved ones.
Your estate is the value of everything you own, including legal rights, interests and entitlements to any assets. But there are some complex allowances against that total and several factors come into play:
The inheritance tax (IHT) threshold is £325,000 per person. So if the total value of your estate exceed £325,000 any amount above that may be taxed at 40%
You may leave your home (primary property) to your spouse with no tax liabilities, meaning the IHT amount only covers assets over and above your home. Note: you must be legally married or have have civil partnership to get this benefit, The HMRC does not recognise cohabiting
The residence nil rate band (RNRB) is £175,000. You benefit form this when you leave your home to a direct dependent. Note: this may be your child, step-child or their descendants (your grandchildren)
For a couple who are married or have a civil partnership, these allowances transfer, so if one person passes away and leaves their half of their home and all their assets to their spouse, their spouse then has two lots of IHT allowance and two lots of RNRB. That totals £1m. Note: this only applies if the first person leaves all their assets to their spouse and if the spouse leaves the home to children or grandchildren. If you split your estate among other beneficiaries, such as brothers or sisters, nephews or nieces, or close friends, then this transfer of allowances does not apply
If the value of the life insurance payout takes the person who passed away above the tax-free limits after taking into account all the possible allowances, then any amount above the allowances will be subject to IHT. The current rate of IHT is 40%
If your estate is valued higher than the tax inheritance threshold, your life insurance pay out will form part of your estate and thus be subjected to the 40% inheritance tax.
This can be a headache for the family you leave behind. They might end up having to use the remainder of your life insurance pay out to pay off some inheritance tax bill, rather than the mortgage, or any other debts that it was intended to pay off in the first place.
Writing your life insurance in trust means that even if your estate is subject to inheritance tax, you can leave behind some money that is just for your loved ones, or even to pay off your entire inheritance tax bill.
Most life insurance policyholders don't have theirs put in trust, despite the benefits. It may not always be for everyone, but most of the time it's a decent piece of forward planning that could save your loved ones thousands of pounds. So just how does it work exactly?
Putting your life insurance policy in trust involves a legal arrangement that helps to ensure that the money from that policy is used exactly as you intended, regardless of the value of your estate. If you don't have a trust, then the money will be used to pay off any debts you have left outstanding upon your death.
Even if you have not written a will, a life insurance policy in trust will still apply, i.e. will not need probate to be granted (this is jargon for a legal process which confirms if someone is authorised to deal with your possessions - it can still apply if a will has been written, but can take much longer if not).
With a life insurance policy in trust you can specify who receives the money and how much they get. It also means that your beneficiaries will receive the money much quicker, whether a will has been written or not.
Often getting access to money and assets from your will can take much longer, but with a life insurance policy in trust, the money can sometimes reach your loved ones within a couple of weeks of the death certificate being produced. If the policy is not written in trust it can sometimes take several months for your beneficiaries to receive the money, if it hasn't already been spent on repaying debts.
Remember, the payments from a life insurance policy written in trust are outside your estate, meaning they are not subject to tax. So if you know your family are going to be faced with an inheritance tax bill after your death, you could even use the life insurance money to pay off your tax bill.
This would mean that the rest of your assets were free to be distributed to your chosen beneficiaries without them having to pay any inheritance tax on it.
Remember, there will be a lot of legal jargon surrounding life insurance policies written in trust. In order for policy to be written in trust, you will be asked to assign a trustee or trustees to manage the assets from your life insurance policy.
This essentially means that someone (or people) you trust will be given the responsibility of ensuring that the life insurance money is paid out exactly as you intended to the right beneficiaries. This is what negates the need for probate to be granted, even if a will has been written.
Writing a life insurance policy in trust doesn't usually cost extra either. You may want to get additional tax and legal advice before doing so, but if you're happy to go ahead with it, you can ask your life insurance provider to write the policy in trust when taking it out. You can also transfer some existing life insurance policies into trust, but in these cases you should probably speak to an independent legal advisor first.
Finally, and perhaps most importantly to note: once a life insurance policy has been set up in trust, it can't be cancelled. This is because control has been given to your trustee or trustees. As a result, you can't make any changes to the pay out terms. So it's important that when you write your life insurance policy in trust that you are absolutely certain about whom the money is for.
If you have any doubts or are overwhelmed by the enormity of the decision - especially because it’s one you can't go back on - then certainly speak to an independent advisor to get the necessary tax and legal advice first.