Avoid 40% inheritance tax and probate on your life insurance pay out!
Are you getting the most out of your life insurance? Join the 6% of people who write their life insurance in trust.
Paying into a life insurance policy is a significant financial commitment over many years.
Obviously, life insurance provides financial security for your loved ones, but it does involve making monthly payments for a huge period of your life.
So, when the day comes, you want to make sure your loved ones benefit fully from your selfless investment.
One of the best ways to do this is to write your policy in trust.
Writing your policy in trust is a free service provided by most insurers, but despite this, only 6% of policyholders make use of this option.
Perhaps this is due to lack of awareness, misunderstanding of the benefits it provides, or even just pure intimidation of the application process.
What is writing your life insurance in trust?
Writing your policy in trust involves appointing people you have complete faith in to be responsible for your life insurance policy upon your death.
It is essential you choose your trustees wisely as you are effectively handing the value of your life insurance policy over to them to distribute on your behalf.
It is a very similar process to appointing an executor of a will.
There are a number of significant benefits from undergoing this process.
Writing your policy in trust offers three key benefits;
- Avoid (or minimise) 40% inheritance tax
- Bypass the probate process
- Have better control over your policy.
If your life insurance policy isn’t written in trust, it forms part of your legal estate – which is subject to inheritance tax.
Anything over the value of £325,000 is subject to inheritance tax, meaning the overall value received by your loved ones can be reduced significantly.
Writing your life insurance in trust detaches the value of your policy from that of your estate meaning that regardless of your policy value it will not be subject to tax.
Also, this means that the extent at which your estate exceeds the £325,000 threshold is smaller and will also be subject to a lower amount of tax.
Additionally, in order to gain access to the value of your estate, your loved ones have to undergo the probate process – which is a way of proving they are fit to administer your assets.
This process can be very lengthy, sometimes even taking years.
If your life insurance policy isn’t detached from the value of your estate, your beneficiaries will have to undergo this probate process before they are able to gain access to your life insurance pay out, as well as the rest of your estate.
If these funds are needed to cover the costs of your funeral and various other legal fees associated with dying, it could result in your loved ones having to foot the bill until the sum of your life insurance can be retrieved to payback these costs.
Finally, if your life insurance policy isn’t written in trust, upon your death the value can be demanded to cover the costs of outstanding debts or other required arrears.
Writing your policy in trust allows you to determine who the pay out sum goes to and what it is used for (to a certain extent, based on the decision of the trustees), allowing you to assure an inheritance for your loved ones or provide a charitable donation.
When writing your life insurance in trust isn’t as necessary
In the large majority of cases, policyholders will benefit from writing their life insurance policies in trust, however, there are a couple of scenarios where this process is not necessarily essential.
The first of these scenarios is when the policyholder also has in place a will.
Within your will it is possible to state who you would like to leave your life insurance policy pay out to and in what distribution.
This is similar to writing your policy in trust, but rather than it being the responsibility of the trustees to carry out your wishes, it will be the responsibility of the executor of your will.
This, however, will mean your life insurance policy will form part of your estate and as a result will require your beneficiaries to undergo the probate process as well as the value being subject to inheritance tax.
The other instance where writing your life insurance in trust may not be necessary is if the policy you hold is joint.
In this instance, the pay out sum would be made directly to the surviving spouse, making it void to inheritance tax.
The only instances this could present an issue is if both partners were to die simultaneously or the policy held was a survivorship policy where a pay out is made on the death of the second partner.
Both of these would result in the pay out being made to a beneficiary other than a spouse, meaning it would be subject to probate and inheritance tax.
Types of trust
Generally speaking there are three different types of trust you can write your policy into.
Each one offers a different level of flexibility and therefore different benefits.
The first of these is an ‘absolute trust’, also often referred to as ‘bare’ or ‘fixed’ trusts.
These tend to be the most rarely offered type of trust and are fairly inflexible.
With this type of trust, you name your beneficiaries and decide how you would like the pay out sum split.
This decision cannot be changed at a later date, therefore can cause issues if your circumstances change, for example, you get divorced or have more children.
Flexible trusts, however, allow you to name beneficiaries and how you would like the pay out to be split, but you also have the ability to update these at a later date.
With this type of trust, you also have the ability to name potential beneficiaries, such as future children/grandchildren.
Whilst this type of trust is appealing if you think your circumstances may change, it does require you to have the utmost faith in your trustees as they have the authority to change the beneficiaries and pay out split if they deem fit.
The final type of trust available is a discretionary trust and is by far the most flexible type available.
No beneficiaries are named, and all decisions are left to the trustees. A list of potential beneficiaries and ‘letter of wishes’ can be provided to declare how you would like the pay out to be handled, but all decisions are made solely by the trustees.
If you feel your circumstances may change it is important you choose a trust type which accommodates this level of flexibility, but it is also essential you carefully choose your trustees to ensure they will carry out your wishes as you desire.
It’s worth noting that it can be difficult to change the details of beneficiaries even if the trust type allows that level of flexibility and it can be even more difficult to remove a policy from trust once it has been written into one.
Trust writing guidance
When looking to write your life insurance in trust it can look pretty daunting, especially when the stakes are so high, but rest assured it doesn’t have to be a difficult endeavour.
Many life insurance brokers will provide a free trust writing guidance service to help talk you through the process of writing your policy in trust and answering any questions you may have along the way.
Life insurance in trust summary:
- Hands over the value of your life insurance policy to a group of trustees
- Various trust types are available offering differing levels of flexibility
- Once written in trust, it can be difficult to make changes or remove the policy from trust
- Writing your policy in trust can help reduce inheritance tax, bypass probate and take control of your policy
- If you have a joint policy or a will, writing your life insurance in trust may not be as necessary but could still offer benefits
- Using a trust writing guidance service can help you with the process to avoid it being so daunting.