When it comes to planning your family's financial future it is important to look at all areas affecting your finances. One area that is overlooked by the majority of people is the use of a trust deed linked to their life insurance policies. If you don't have life insurance then read my article "How much life insurance do you need?".
What is a Trust?
A trust is a legal document that allows you to set aside an asset for the benefit of a specified person or people (the beneficiaries). The asset is then managed by a trustee who is also nominated by the policyholder (the settlor). The trustee accepts responsibility for ensuring that the benefits/monies paid into the trust are distributed to the named beneficiaries according to the deceased's wishes.
If you set up a trust with your life insurance policy, the insurance company will pay out to the trust rather than to your estate when a death claim is made. A death certificate will need to be presented to the insurance company for the claim to be processed then the trustees will be notified so that they can carry out their responsibilities.
Life Insurance policies are an asset that can be placed in a trust and this can have a dramatic consequence on how the payout is dealt with in the event of death.
How does a Trust work?
A trust is a legal arrangement that wraps your life insurance benefits if a death claim is made. The trust relies on nominated individuals carrying out legal duties to distribute the money that is paid into the trust in the event of a claim according to the wishes set out by the insured person known legally as the settlor.
You will be required to nominate a trustee but it is usually wise to nominate more than one so that they confer on the best way to execute your wishes but also in case your nominated trustee is no longer around to carry out the duties.
You will nominate your beneficiaries and you will also stipulate how your life insurance benefits are to be split amongst them - you can choose to allocate a percentage of the life insurance payout to each beneficiary.
The trustees and beneficiaries can sometimes be the same people but in circumstances where the beneficiaries are under the age of 18, they cannot be trustees. You have to be over the age of 18 in order to be a trustee and assume the responsibilities that go with this. Often people nominate their children as beneficiaries and it is possible to do this as long as they are over the age of 18 years old. It's worth bearing in mind that you can add trustees in the future when your children reach the age of 18 if you want this to be the case.
There are different types of life insurance trusts that you can use depending on your needs including a flexible trust, discretionary trust and absolute trust. You may need to seek legal advice or speak to a life insurance expert to ensure you use the correct trust deed. We explain how to arrange this later in this article.
What is the benefit of writing a life insurance policy in trust?
Arranging a trust with your life insurance has the obvious benefit of ensuring that the payout reaches your intended beneficiaries. In addition to this, you'll also find efficiencies in the time it takes to get the monies to your beneficiaries and any tax implications.
Name your life insurance beneficiaries and trustees
This is the obvious benefit, in that you are able to name your beneficiaries and trustees. The beneficiaries are the people you wish to benefit from the money that is paid from your life insurance. The trustees are the people that you wish to nominate to carry out the distribution of these monies to your beneficiaries. Trustees are required to authorise their consent to take on trustee responsibilities when you arrange the trust.
Also, by writing a life insurance policy in trust you have control over exactly who will benefit from the proceeds. You can even split the benefits between multiple beneficiaries, apportioning the split as you wish.
Often, if your beneficiaries are minors, you will need to consider which adults to nominate and entrust with the benefits from your policies in the form of trustees. There is also value in aligning those individuals that you have nominated as potential guardians for your children through your will, to a trust so that they can access the funds that you wish to be used for the benefit of minors.
Reduce inheritance tax on your life insurance payout
Under normal circumstances and without a trust in place, the payout from a life assurance policy forms part of your estate and therefore could be subject to inheritance tax. The threshold for inheritance tax in the UK is currently £325,000 (2023/24). That means that your assets that exceed this amount could be subject to Inheritance Tax which is currently set at 40%. This doesn't apply to benefits passed between spouses.
By putting the assets from your life insurance in a trust, you separate these assets from your estate. This means that they do not add to the value of your assets that will be assessed for Inheritance Tax. Of course, this relies on the current rules around Inheritance Tax remaining the same and these are always subject to change so regular reviews are sensible.
Advice around whether you should arrange a trust for mortgage life insurance varies but it is useful to note some benefits here. The first is that the speed of putting the assets into the hands of those who will need them to pay for the mortgage is pertinent. The second is that separating the assets will mean that the value of your estate may be reduced, as probate will assess the mortgage liability as part of this. In some cases, this may reduce the amount of inheritance tax payable.
Get your life insurance payout to your beneficiaries faster
When an insurance company agrees to pay a life insurance claim, they will either pay the benefits to the deceased person's estate or to the trust if there is a trust in place. A deceased person's estate goes through a process of probate and this process can take some time. In many cases, months can pass before probate is granted and the assets within the estate are realised by those who will inherit it. In very complicated scenarios, this timeline could be even longer.
If your life insurance is set up jointly with your partner, the money that is paid out should be paid directly to your surviving partner even if you do not have a trust in place.
By arranging a trust you can ensure that the proceeds will be paid quickly as the benefits do not go through the process of probate. This can go a long way to reducing the financial hardship that might be endured by your family while they wait for assets to be allocated to them. Unfortunately, bills, mortgage payments and the cost of living do not stop and have to be met. This can be difficult in situations where the deceased person's income would previously have been relied upon to pay these bills.
Are there any drawbacks to writing a life insurance policy in trust?
No, not really but it is important that you review your circumstances from time to time to ensure that your wishes are correctly reflected in how the trust has been arranged. Also, there is more than one type of trust to suit different requirements so you may want to seek professional advice. You may need assistance in circumstances where you wish to change the trustees and/or beneficiaries you originally nominated. Good life insurance companies have trained staff who provide specific guidance to customers who are arranging a trust.
How to arrange a trust when buying life insurance
Putting a life insurance policy in a trust can ensure that the full proceeds of the policy are paid quickly to those intended, without being reduced by an inheritance tax payment. Transferring an existing life insurance policy into trust can be straightforward with a little help from your life insurance provider. Most life insurance companies will provide you with the documentation to put your life insurance in trust but you may have to get guidance from a solicitor to complete the paperwork. It is much easier to arrange your trust when you start your life insurance policy as a good life insurance adviser will help you with this.
If you have yet to buy life insurance, but plan to do so and like the idea of arranging life insurance written in trust, then speak to an expert life insurance adviser*, as they have a dedicated service that will ensure that your policy is placed into a trust. Even better, the service is free and you will receive up to £100 cashback as Money to the Masses reader!
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