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 in connection with 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 allows you to set aside an asset for the benefit of a specified person or group of 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.
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.
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.
What is the benefit of placing 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 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.
Under normal circumstances and without a trust in place, the payout from a life assurance policy forms part of the deceased person's 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.
Speed of realising benefits
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 may be even longer.
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
Placing a life insurance policy in a trust will ensure that the full proceeds of the policy are paid quickly to those intended, without being reduced by an inheritance tax payment.
If you have yet to buy life insurance, but plan to do so and like the idea of placing it into 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!
If a link has an * beside it this means that it is an affiliated link. If you go via the link, Money to the Masses may receive a small fee which helps keep Money to the Masses free to use. This link can be used if you do not wish to help Money to the Masses and do not wish to qualify for the cashback referred to in the article