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Life insurance trusts - they make sense
A trust is basically a legal arrangement which helps people to manage and control their finances. Think about when you die (a horrible thought, but bear with us), you will probably want to pass on some of your assets - like property, savings and investments, to loved ones. You may have a will, in which you’ve specified who should inherit your money, but trusts can come in handy too, especially if you have a life insurance policy which will pay out a lump sum of money when you pass away.
The answer to this is probably yes, and yet only 6% of people put their life insurance policies in trust according to the insurer, Aegon. There are three key reasons why it’s a good idea to put your policy into a trust:
To reduce your inheritance tax bill
Some of us will need to pay inheritance tax when we pass away, which is currently set at a whopping 40%! But don’t worry, not everyone will need to pay inheritance tax, and the 40% is only applied to the value of your estate - that’s your property, money and possessions, above £325,000. Inheritance tax can get a little confusing, so we’ve created this handy guide to break things down a bit.
To speed up payment from a life insurance policy
Did you know that your money, possessions and property will probably have to go through probate when you pass away? Probate is a legal process which gives the executor of your will - the person you named to be in charge of everything, permission to manage your finances when you pass away. Once permission is granted, the executor will need to gather all of your assets, including your life insurance payout, pay any outstanding bills and debts, and then distribute out the remaining money and possessions according to your will. The probate process can take 12 months to complete, and the time will often depend on the complexity of your finances - assets like property and investments can make things a little more complicated.
To give you and your loved ones more control
By using a trust, you’re in control and can rest assured that your full life insurance payment will go to exactly who you want it to. Of course, you’re able to do something similar with a will, but without a trust, your life insurance policy will form part of your estate, so the insurance payout could be used to pay off any outstanding debts or bills, reducing the amount that eventually passes to your loved ones. Setting up your life insurance policy inside a trust provides certainty that your loved ones will receive the insurance payout they need, should the worst happen.
So how can trusts help to reduce your inheritance tax cost? Well the key is in the phrase ‘your estate’. The 40% tax rate is applied to the value of your estate, which a life insurance pay out can form part of. That is, unless you put your policy in trust! Setting up your life insurance policy inside a trust separates it from the rest of your money and possessions, so when you die the life insurance payout doesn’t get combined with the rest of your finances for the inheritance tax calculation, and instead goes directly to your loved ones*.
As we mentioned, not everyone will need to pay inheritance tax, but if you are one of the unlucky ones, a trust is an absolute no brainer in our opinion!
Death is horrible, and really the last thing you want to be doing is going through a whole host of legal processes, admin and months of waiting, in order to access the money and possessions left to you, especially if you’re reliant on two incomes to cover the monthly bills and mortgage repayments. That’s where a life insurance trust can help, because your policy will sit separately from the rest of your finances - it won’t form part of your estate, so won’t need to go through the lengthy probate process. If your life insurance policy is written in trust, the only thing your loved ones would need to provide before accessing the payout is a death certificate, and the insurance payment should be made in as little as a few weeks.
So you’ve decided that you’d like to put your life insurance policy in trust. The first step is to get clear on who you’d like to manage your policy and who will receive the benefit. You’ll need to assign the following roles:
- Settlor - this is you! As the policyholder you’ve decided that you’d like to set up the trust and transfer ownership of your policy to the trustees.
- Trustees - these are the people who are responsible for managing the policy and the insurance payout when you pass away. These would typically be people that you trust (clue’s in the name), maybe close family or friends, or even your solicitor. You may also decide to be a trustee yourself so that you can make any necessary changes, but when you pass away your duties will pass to the other trustees, so it’s also a good idea to choose people who are expected to live longer than you.
- Beneficiaries - these are the people who you’d like to receive the life insurance payout.
Once you’ve decided on the above roles, your insurer will be able to complete the process for you - if it's a new policy.You may also be able to put an existing life insurance policy in trust, but you should speak directly with your insurer or your protection adviser for help with this.
Types of trust for life insurance
There are two main types of trust - absolute trusts and discretionary trusts. There are a few differences between these two types, but the main one is the level of flexibility you have. With an absolute trust, the beneficiaries are decided and can’t ever be changed, whereas with a discretionary trust, trustees can add and change beneficiaries and also decide when payments are made to beneficiaries.
Another type of trust worth knowing about, especially if you have a life and critical illness insurance policy, is a split trust. Usually you, as the policyholder, can’t be a beneficiary of the trust, which means that if you fell seriously ill you may not receive the insurance payout. A split trust allows you to split the critical illness and life elements of your insurance policy, so that you can receive the illness payout if you need it, and the death payout stays protected from inheritance tax and is managed by the trustees.
We’re here to help. You can contact your adviser directly with any questions you may have; Or alternatively, you can speak to your insurer for more information.
*Tax rules are subject to change.
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Katie is an independent insurance consultant who is passionate about protection and wants to share that passion with others through engaging marketing content. She hopes that one day people will get as excited about protecting themselves and their loved ones, as she does!See all articles by Katie Crook-Davies
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