Putting Life Insurance in Trust
One of the biggest considerations for anyone looking to get a life insurance policy is that of what happens to the money once it is claimed.
Will it be used as you intended? Will it get to the right people? Will it be eaten up by inheritance tax?
Writing a will is a good way to deal with many of these issues, but an alternative is writing the life insurance policy into trust.
By putting money in trust you ensure your wishes regarding the funds are paramount and can get the money to your beneficiaries in a far smoother and faster way following your death.
What is a life insurance trust?
A trust is a legal agreement whereby you specify the conditions regarding how your life insurance money is to be used.
There are three parties involved in a trust:
The settlor – this is the person who owns the policy that will be paid into the trust: you.
The trustees – these are the people who manage the trust on your behalf. It should be two or more people and can include your solicitor or a trust company if you wish, though it could also be any two people you trust. It is common for one of the trustees to be your spouse or civil partner.
The beneficiaries – these are the people who benefit from the trust money. With your life insurance this is typically your partner and children, though it can include anyone you wish to receive money from your life insurance, including friends or charities. Both the settlor and trustee can be a beneficiary as will be explained further.
What are the life insurance trustee responsibilities?
The trustees are legally responsible for managing the trust and ensuring that money is passed to the beneficiaries in the way the trust details.
Depending on the type of trust, the trustees could also be given the responsibility of investing the funds as they see fit and passing the profits of any investment on to the beneficiaries.
Other types of trust seek to limit the trustees’ responsibilities and simply require that the money is passed on in full at an appropriate time.
Some examples of trustees’ powers and actions can include:
Managing money for a minor, in their best interest
Often a surviving parent is given the life insurance money in trust for the children.
This type of life insurance discretionary trust would give the parent the power (agreed with the other trustees) to use the money in any way they consider to the benefit of the children.
A family holiday, for example, would be a legitimate use of the trust, however a personal spa day with the children left with a grandparent would not.
Purchasing property on behalf of minors
The trustees could decide to invest in and manage property for the children to own.
Any profit made from rental income of the property would be passed back into the trust, as would any money made from the eventual sale of the property.
Paying for medical care
If the beneficiary falls ill, the trustees could release money from the trust fund to pay for their treatment and care.
Holding the money until a designated age
The trustees could be responsible for holding the money securely until a minor reaches their eighteenth birthday, at which time the funds are released to them.
The trust might require a staggered release, with 10% of the total being given to the beneficiary annually from 18 to 27.
Why have a life insurance trust?
When you die, your chattels (personal possessions) and assets (money, property and other financially-relevant belongings) are passed to your heirs based on the instructions laid down in your will.
If you haven’t written a will, then you are said to have died intestate and the means by which your assets are distributed is determined by the laws of intestacy.
In both cases, the value of your estate is calculated and may incur a payment to HMRC for inheritance tax (if the total value is over £325,000). In some cases, this might require the sale of the family home.
In the case of intestacy, your assets may not be divided as you would wish, and could be passed to someone you wouldn’t want to have your money.
It takes time for your will to be read, your estate calculated and the assets to be passed to your heirs. This period is called ‘probate’ and can take months to complete.
By setting up a trust for your life insurance, your life insurance payout is made to the trustees and not to your estate.
In this way you avoid both inheritance tax and the probate process, getting your money to its intended beneficiaries in full and without delay – something that can be very important if your family is left without a salary and have to cover mortgage payments and other bills during a time of grief.
It is legal to have trusts to avoid inheritance tax?
You have the legal right to have your life insurance paid as you see fit – including into a trust. This method is highly regarded and is often used to provide to pay inheritance tax on larger estates.
For example, if you own assets with a combined value of £600,000 then (in an over-simplified way) you could expect to pay 40% inheritance tax on £275,000 of that – a total of £110,000.
Setting up a life insurance policy in trust for £110,000 would mean that upon your death the trustees would get access to funds specifically set aside to pay the inheritance tax bill.
As this life insurance policy is outside of your estate, it is not liable for inheritance tax itself and by making the executor of your will the beneficiary of the trust fund, they will be able to immediately pay the inheritance tax bill.
Setting up a trust to avoid inheritance tax on your life insurance payout is sensible, as is setting up a life insurance policy to pay the inheritance tax on the remainder of your estate!
Should you put life insurance in a trust – what are the life insurance trust advantages and disadvantages?
While most life insurance policies would see a benefit to being put into trust, data from Aegon suggests that only 6% of those in the UK are!
The main reason for this is, of course, a lack of understanding regarding trusts and their benefits. Delving into trusts can be very confusing and it’s an extra level of personal finance management that many people simply avoid.
The main disadvantage for some, however, is the irrevocable nature of a trust. Simply put – there’s no going back or changing your mind and once your life insurance policy is written into trust, then that’s it!
This can have particular consequences should your family or relationship circumstances change.
A divorced spouse who was once placed as both trustee and beneficiary will always remain as that, even if you go on to remarry and have a second family.
In those cases, the only way to change the situation would be to cancel the entire life insurance policy (simply a case of stopping paying for it!) and start a new one.
Depending on the length of time it’s been since your original policy was started, chances are high that a new policy will struggle to be as good a deal.
For most people, the advantages far outweigh the disadvantages:
Your life insurance is not subject to inheritance tax
Your beneficiaries receive the money immediately, without a long probate process
The trust cannot easily be contested
You can exercise more control over the funds
Trust is irrevocable – policy must be cancelled entirely to change beneficiaries
An extra layer of administration
Trustees must be willing
Complicated trust arrangements may require external legal advice
How does life trust insurance work with combined policies such as critical illness cover?
When you write your policy into trust you essentially pass yourself over as having control of the money when it is paid out.
Critical or terminal illness cover and trusts
In the case of your death this has no impact, but when your life insurance policy also includes critical illness cover it could prevent you from accessing the funds specifically designed to help you through hardship.
Thankfully, the insurance companies have considered this and almost all life insurance trust forms provided by insurers cover this eventuality, creating a split trust where you become a beneficiary for critical illness cover and any other similar cover meant for you during your lifetime.
Income protection, mortgage payment protection insurance and life insurance trusts
Unlike critical illness cover which is combined with your life insurance, income protection and MPPI are typically separate policies.
If they are not, then check with your insurer that these form a split trust in a similar way as critical illness cover described above.
Joint life insurance in trust
Joint life insurance can be placed into trust with as much ease as an individual policy and provides all of the same benefits.
With joint insurance, the second policy holders will each be named beneficiaries (and potentially trustees) along with the children, creating a situation where settlor, trustee and beneficiary may all be the same person.
How to set up a trust for life insurance
Life insurance trusts are easily set up when you apply for your policy – simply tell your life insurance broker that you’d like to write your policy into trust and they’ll supply the appropriate forms.
These are far simpler to fill in than you might expect, as most policies and requirements follow a standard set of instructions.
If your family situation is complicated, or if you wish to make your details regarding the trust known (including if you want to stagger money for children, for example), then you will need legal assistance to write a more in-depth trust document.
Can you transfer your life insurance policy into trust?
While a trust cannot be undone, that doesn’t mean that a policy not in trust can’t be put into trust. Contact your insurer and they’ll help you transfer any existing policy into a trust inheritance.
How much does it cost to write a trust?
A basic trust with your life insurer will be free – it’s just a simple form.
However, if you need a more in-depth trust contract then you should contact a specialist solicitor and you will need to pay their fees.
Do you need a will if you have a trust?
We advise always having a will. Remember, a life insurance trust will not cover any of your existing savings, property or possessions.
It is possible to use multiple trusts to render a will worthless, and if your life insurance forms the majority of any estate then it could be possible to focus entirely on a well-described trust.
Typically though, the answer is yes, and you should always consider a will in addition to any extra security provided by the trust.
Should I put life insurance in trust?
If you want your life insurance money to go cleanly and effortlessly to your children, then a trust policy is an excellent idea worth considering.
Another way of getting the most out of your life insurance is by taking out a policy with a free gift.