Setting up your life policy in trust is a simple and free way to make things easier for your family if the worst happens.
From a financial point of view, setting up a life insurance policy is one of the most far-sighted steps you can take.
Making sure your partner and children would be looked after if the worst happened gives you peace of mind. Life cover means that your mortgage repayments, for example, would be dealt with if you died, so your family would not be forced to move out.
And your policy could also pay a lump sum to help your dependants cope with ongoing living expenses.
But the vast majority of life insurance policyholders are unwittingly creating potential difficulties for their families – and possibly adding thousands of pounds to their tax bills – by failing to make a simple adjustment to the way the cover is set up.
Putting your policy in trust
When you buy life insurance, you have the option of setting the policy up “in trust”.
What this means is that the cover is essentially ring-fenced outside the rest of your assets, such as savings, investments and property. You decide in advance who is to benefit from the trust, and these people are known as the beneficiaries.
You also appoint a trustee to take charge of the trust: they are responsible for carrying out your wishes.
So what are the advantages of setting up – or “writing” – your life insurance policy in this way?
- Cutting red tape: The first reason to use a trust is to ensure that your life policy pays out as quickly as possible.
If you die and your policy is not in trust, the proceeds from it will be collected together with the rest of your estate to go through a process known as probate. This is the legal requirement to make sure your assets are divided up among the beneficiaries in accordance with your will.
In many cases, probate can take a long time – months, even – which could leave your family desperately short of cash for living and housing expenses.
If your life policy is in trust, however, the proceeds from it are allowed to sidestep the probate process and can be paid directly and immediately to those who need the money most.
- More control: If your policy is in trust you can be more specific about who benefits from it as it is not covered by the instructions in your will.
For example, if you have young children you can stipulate that any money held in the trust from a life-insurance payout passes directly to them. You can also dictate when they receive it, such as when they turn 18 or 21.
- Less inheritance tax: Outside of a trust, the payment from a life insurance policy is added to the value of your estate for inheritance tax purposes.
Imagine you had assets of £250,000 plus a life insurance payment of a further £150,000 when you died. This would give you a total estate value of £400,000.
At present, the nil-rate band on inheritance tax is £325,000 per person: any bequest above this level is taxed at 40 per cent.
In this example, that would create an inheritance tax bill of £30,000.
However, if your policy was written in trust it would not count towards your estate and your family’s tax bill would be zero.
(There are other ways to cut inheritance tax: for example married couples can pool their nil-rate bands.)
Despite these potential benefits, only around one in every 15 UK life insurance policies is set up in trust, according to recent figures from insurer Aegon.
How to write your policy in trust
When you have found a life insurance quote that you are happy with, you should talk to the provider about setting the policy up in trust. This should not cost extra.
Using a trust is not always the best option – for example, if you have taken out a policy solely to cover your mortgage commitment. This is something the insurer will be able to guide you on.