Life Insurance Trusts

Life insurance is clearly a significant financial concern. For many couples, the main breadwinner's life insurance policy represents the possibility of financial security after that individual's death.

These policies are, however, frequently undervalued in every sense; many people do not have life insurance at all, and many of those who do are vastly underinsured. Finally, the vast majority of those who do have adequate policies have not taken sufficient precautions to ensure that the policies are protected from inheritance tax.

Inheritance Tax

Trusts can be used to ensure that life insurance policies provide the maximum potential benefit for those to whom they are paid out. This can be particularly well illustrated by looking at the likely outcome of a situation in which a life insurance policy is paid out without the use of a trust.

When this occurs, the policy will be paid into the estate of the deceased individual. If this individual is a homeowner, it is potentially highly likely that this will create or increase a liability for inheritance tax (IHT). Inheritance tax is currently payable on assets over £325,000, and is levied at a rate of 40%. Thus, if the estate of the individual totals more than this figure, their heirs will lose 40% of all, or at least part, of the life insurance pay-out.

When a life insurance policy is 'written in trust', however, the outcome is potentially very different. Under this arrangement, the money that is paid upon the death of the policy-holder is not counted as part of their estate. Rather, it will pass directly to the intended beneficiaries; these will be detailed in the policy itself and in the document used to establish the trust. Because the money has skipped the estate of the policy holder, it will not incur an IHT liability. As was illustrated above, this means that the heirs will save up to 40% of the entire value of the policy.

The Process

Writing a life insurance policy into trust is incredibly easy, and may well be free. It seems that many life insurance companies do not offer the relevant forms as standard, but should be happy to do so if requested. If you are using a broker you will need to pass the details of the beneficiaries on to them; they will then complete the form and forward it to you for signing.

It is important to note that writing a life insurance policy into trust will not necessarily absolve your heirs' heirs of their tax liability. In order to achieve this, the beneficiaries of your policy should ensure that they have taken proper steps to mitigate their exposure to IHT. This can frequently be achieved through the creative use of trusts, particularly Nil-Rate Band Discretionary Trusts. These are investigated in more detail in an article elsewhere on this site.

While writing a life insurance policy into trust should not require legal advice, in some circumstances you may wish to seek independent financial advice to ensure that this is the best course of action for you.