Should You Put Your Life Insurance in Trust?

Did you know that your life insurance policy could be subject to inheritance tax if you don’t put it in trust? According to HM Revenue & Customs (HMRC), inheritance tax is charged at 40% on estates worth more than £325,000¹. This means that if your total estate, including your life insurance pay out, exceeds this threshold, your loved ones could end up paying a hefty tax bill when you’re gone.

But there’s a way to avoid this. By putting your life insurance in trust, you can ensure that your policy is legally owned by someone else (the trustee) and is not part of your estate. This means that it won’t count towards the inheritance tax threshold and your beneficiaries will receive the full pay out.

Putting your life insurance in trust also has other benefits. For example, you can have more control over who gets what from your policy. You can also speed up the process of releasing the money to your beneficiaries without having to wait for probate. Probate is the legal process of dividing up your assets after you die and can take months or even years to complete.

In this article, we’ll explain everything you need to know about putting your life insurance in trust. We’ll cover:

• The different types of trusts that you can use for your life insurance policy
• How to set up a trust for your life insurance policy
• The pros and cons of putting your life insurance in trust

By the end of this article, you’ll be able to decide whether putting your life insurance in trust is right for you or not.

Key Takeaways

What is a trust?	A legal arrangement that allows you to leave assets (such as your life insurance policy) to someone else (the trustee) who will manage them on behalf of your beneficiaries
What are the benefits of putting life insurance in trust?	– It can reduce or eliminate inheritance tax on your policy pay out <br> – It can give you more control over who gets what from your policy <br> – It can speed up the process of releasing the money to your beneficiaries
What are the drawbacks of putting life insurance in trust?	– It can be costly and complex to set up <br> – It can have legal and tax implications for you and your trustees <br> – It can be irreversible once it’s done
What are the types of trusts for life insurance?	– Discretionary Trusts: your trustees have discretion over who and how much to pay from your policy <br> – Flexible Trusts: you have default and discretionary beneficiaries who can receive income or capital from your policy <br> – Survivor’s Discretionary Trusts: your policy pays out to the surviving policy owner first, then to your beneficiaries <br> – Absolute Trusts: you have fixed beneficiaries who cannot be changed
How do you set up a trust for life insurance?	– Choose the trustees, beneficiaries, and type of trust that suit your needs <br> – Fill in a trust deed form provided by your insurer or a solicitor <br> – Sign the trust deed and send it to your insurer or a solicitor <br> – Keep a copy of the trust deed and inform your trustees and beneficiaries

Types of Trusts for Life Insurance

Before you put your life insurance in trust, you need to decide which type of trust is best for you. There are four main types of trusts that you can use for your life insurance policy:

• Discretionary Trusts
• Flexible Trusts
• Survivor’s Discretionary Trusts
• Absolute Trusts

Each type of trust has its own features, advantages, and disadvantages. Let’s look at them in more detail.

Discretionary Trusts

A discretionary trust is a type of trust where your trustees have a high level of discretion over who and how much to pay from your policy. You can name a group of potential beneficiaries, such as your spouse, children, grandchildren, or anyone else you choose. However, you don’t specify how much each beneficiary should receive. Instead, you leave a letter of wishes to guide your trustees on how to distribute the money according to your intentions.

The main advantage of a discretionary trust is that it gives you flexibility and control over your policy. You can change the beneficiaries or the letter of wishes at any time, as long as your trustees agree. You can also add new beneficiaries, such as children born later or a new spouse after a divorce. A discretionary trust also allows you to avoid inheritance tax on your policy pay out, as it’s not part of your estate.

The main disadvantage of a discretionary trust is that it can be complex and costly to set up and maintain. You need to choose reliable and trustworthy trustees who will follow your wishes and act in the best interests of your beneficiaries. You also need to consider the tax implications for your trustees and beneficiaries, as they may have to pay income tax or capital gains tax on the money they receive from the trust.

An example of a discretionary trust is:

• You have a life insurance policy worth £500,000
• You set up a discretionary trust with your spouse and your solicitor as trustees
• You name your spouse, children, grandchildren, siblings, and nieces as potential beneficiaries
• You leave a letter of wishes stating that you want your spouse to receive enough income from the policy to maintain their lifestyle, and the rest of the money to be divided equally among your children and grandchildren
• When you die, your trustees decide how much to pay each beneficiary based on your letter of wishes and their circumstances

Flexible Trusts

A flexible trust is a type of trust where there are two types of beneficiaries: default and discretionary. The default beneficiaries are entitled to any income from the policy as it arises. In practice, if the life policy is the only asset in the trust, there will not be any income. The discretionary beneficiaries only receive capital or income from the policy if the trustees make appointments to them during the trust period. If no appointments are made by the end of the trust period, the default beneficiaries will receive all the benefits.

The main advantage of a flexible trust is that it gives you some flexibility and control over your policy. You can change the default or discretionary beneficiaries at any time, as long as your trustees agree. You can also add new beneficiaries, such as children born later or a new spouse after a divorce. A flexible trust also allows you to avoid inheritance tax on your policy pay out, as it’s not part of your estate.

The main disadvantage of a flexible trust is that it can be complex and costly to set up and maintain. You need to choose reliable and trustworthy trustees who will make fair and sensible appointments to the discretionary beneficiaries. You also need to consider the tax implications for your trustees and beneficiaries, as they may have to pay income tax or capital gains tax on the money they receive from the trust.

An example of a flexible trust is:

• You have a life insurance policy worth £500,000
• You set up a flexible trust with your spouse and your solicitor as trustees
• You name your spouse as the default beneficiary and your children and grandchildren as the discretionary beneficiaries
• You leave a letter of wishes stating that you want your spouse to receive enough income from the policy to maintain their lifestyle, and the rest of the money to be divided among your children and grandchildren.
• • When you die, your trustees decide how much income and capital to pay each beneficiary based on your letter of wishes and their circumstances

  Survivor’s Discretionary Trusts

  A survivor’s discretionary trust is a type of trust where the policy pays out to the surviving policy owner first, then to the beneficiaries. This type of trust is usually used for joint life policies, where two people are covered under the same policy. The surviving policy owner can use the money as they wish, or put it into another trust for the beneficiaries.

  The main advantage of a survivor’s discretionary trust is that it gives the surviving policy owner access to the money without having to wait for probate. It also allows them to avoid inheritance tax on the policy pay out, as it’s not part of their estate. They can also change the beneficiaries or the letter of wishes at any time, as long as the trustees agree.

  The main disadvantage of a survivor’s discretionary trust is that it can be complex and costly to set up and maintain. You need to choose reliable and trustworthy trustees who will follow your wishes and act in the best interests of your beneficiaries. You also need to consider the tax implications for your trustees and beneficiaries, as they may have to pay income tax or capital gains tax on the money they receive from the trust.

  An example of a survivor’s discretionary trust is:

  • You and your spouse have a joint life policy worth £500,000
  • You set up a survivor’s discretionary trust with your spouse and your solicitor as trustees
  • You name your children and grandchildren as potential beneficiaries
  • You leave a letter of wishes stating that you want your spouse to use the money as they need, and the rest of the money to be divided among your children and grandchildren
  • When one of you dies, the policy pays out to the surviving policy owner
  • The surviving policy owner can use the money as they wish, or put it into another trust for the beneficiaries

  Absolute Trusts

  An absolute trust is a type of trust where you have fixed beneficiaries who cannot be changed. You specify how much each beneficiary should receive from your policy and when they should receive it. Once you set up an absolute trust, you cannot change or revoke it.

  The main advantage of an absolute trust is that it is simple and straightforward to set up and maintain. You don’t need to choose trustees or write a letter of wishes. You also avoid inheritance tax on your policy pay out, as it’s not part of your estate.

  The main disadvantage of an absolute trust is that it is rigid and inflexible. You cannot change the beneficiaries or the amounts they receive, even if your circumstances or preferences change. You also need to consider the tax implications for your beneficiaries, as they may have to pay income tax or capital gains tax on the money they receive from the trust.

  An example of an absolute trust is:

  • You have a life insurance policy worth £500,000
  • You set up an absolute trust with your children as beneficiaries
  • You specify that each child should receive £100,000 when they reach 25 years old
  • When you die, your policy pays out to your children according to your specifications

How to Set Up a Trust for Life Insurance

If you decide to put your life insurance in trust, you need to follow these steps:

1. Choose the trustees, beneficiaries, and type of trust that suit your needs. You can have up to four trustees, including yourself. You can name anyone as your beneficiary, such as your spouse, children, grandchildren, or friends. You can also choose any type of trust that we discussed above, such as discretionary, flexible, survivor’s, or absolute.
2. Fill in a trust deed form provided by your insurer or a solicitor. A trust deed is a legal document that sets out the terms and conditions of the trust. It includes information such as the names of the trustees and beneficiaries, the type of trust, and the powers and duties of the trustees. You can use a standard trust deed form provided by your insurer or a solicitor, or you can customize it to suit your needs.
3. Sign the trust deed and send it to your insurer or a solicitor. You need to sign the trust deed in front of a witness who is not a trustee or a beneficiary. You also need to get the signatures of your trustees and beneficiaries. Once you have signed the trust deed, you need to send it to your insurer or a solicitor for registration and safekeeping.
4. Keep a copy of the trust deed and inform your trustees and beneficiaries. You should keep a copy of the trust deed for your own records and inform your trustees and beneficiaries about the trust. You should also update them if you make any changes to the trust deed.

Pros and Cons of Putting Life Insurance in Trust

Putting your life insurance in trust can have many benefits, but it also has some drawbacks. Here are some of the pros and cons of putting your life insurance in trust:

Pros

• You can reduce or eliminate inheritance tax on your policy pay out. By putting your life insurance in trust, you can ensure that it is not part of your estate and does not count towards the inheritance tax threshold. This means that your beneficiaries will receive the full pay out without having to pay any tax on it.
• You can have more control over who gets what from your policy. By putting your life insurance in trust, you can specify who your beneficiaries are and how much they should receive from your policy. You can also change or add beneficiaries at any time, depending on the type of trust you choose. This gives you more flexibility and control over your policy than leaving it to your will or intestacy rules.
• You can speed up the process of releasing the money to your beneficiaries. By putting your life insurance in trust, you can avoid the delays and costs of probate. Probate is the legal process of dividing up your assets after you die and can take months or even years to complete. By bypassing probate, you can ensure that your beneficiaries receive the money quickly and easily.

Cons

• It can be costly and complex to set up and maintain. Putting your life insurance in trust can involve legal fees, administration fees, and ongoing costs for managing the trust. You also need to fill in various forms and documents to set up and register the trust. You may need professional advice from a financial adviser or a solicitor to help you with this process.
• It can have legal and tax implications for you and your trustees. Putting your life insurance in trust can affect your legal rights and obligations regarding your policy. For example, you may lose access to the money or the ability to cancel or change the policy. You also need to consider the legal responsibilities of your trustees, such as acting in good faith, following the trust deed, and keeping records. Additionally, you need to consider the tax implications for your trustees and beneficiaries, such as income tax or capital gains tax on the money they receive from the trust.
• It can be irreversible once it’s done. Putting your life insurance in trust can be a permanent decision that cannot be undone easily. Depending on the type of trust you choose, you may not be able to change or revoke it once it’s set up. This means that you need to be sure about putting your life insurance in trust before you do it.

Conclusion

Putting your life insurance in trust can be a smart way to protect your policy pay out from inheritance tax and ensure that it goes to the people you want it to go to. However, it also has some drawbacks that you need to be aware of before you make this decision.

To decide whether putting your life insurance in trust is right for you or not, you need to consider: