Putting life insurance in trust

Arthur Childs
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Putting life insurance in trust is an important aspect of your protection that should not be overlooked. The majority of life insurance policies should be put under trust.

It would seem to be the case, however, that only a small proportion of such policies are actually put under trust.

 

You should review your existing life insurance policies in this respect to see if they are actually going to achieve what they were set up for. A good question to ask when looking at each existing life insurance policy is ‘Would this benefit from being put in trust?’

Table of contents

Review by the Office for Tax Simplification

Further to a request by the Chancellor in January 2018, The Office of Tax Simplification (OTS) produced a review recommending ways in which Inheritance Tax could be simplified. 

One of these was to consider ensuring that death benefit payments from term life insurance are Inheritance Tax free on the death of the life insured without the need for them to be written in trust.  However, this is just a point for the Government to consider at present.

Putting life insurance in trust achieves a number of benefits

  • On your death the policy proceeds can be paid to the surviving trustees on production of a death certificate.  It is not necessary to wait for your personal representative to produce a grant of probate (where you leave a valid will) or letters of administration (where there is no valid will).  People are often shocked to find that obtaining probate can take many months or even years.  To make matters worse any Inheritance Tax has to be paid before probate is granted.
  • Using a trust solves the problem that would otherwise arise where the beneficiaries are too young to deal with an inheritance at the time of your death.
  • Most importantly the policy proceeds do not get added to your estate.  If they did they could substantially increase any Inheritance Tax charge. 
  • A trust allows for a great deal of flexibility in your personal financial planning even to the extent of changing who will benefit from the trust.

The use of trusts with different types of life insurance policies

  • Regular premium protection policies – The most common of these would be term insurance policies or flexible whole of life assurance policies.  Where such a policy has been recommended as a means of family protection, or to meet potential Inheritance Tax liabilities, the policy should normally be written under the appropriate trust.  Small estates can get probate within a few weeks so it may not always be appropriate to put small life assurance policies under trust.  As a rule the larger the sum assured the more important the need to put the policy under trust.
  • Regular premium investment policies – The most common of these would be endowment plans or maximum investment plans.  These are no longer popular but there are still some in force.  Unless it is your aim to gift the monies invested to some other person, then the use of a trust will not be appropriate.  The only other exception would be where you want any death benefit to be paid outside of your estate.
  • Policies issued in connection with a mortgage – The most common of these are mortgage protection plans.  Other term insurance policies or flexible whole of life policies may also be used for this purpose and there are still a few mortgage endowment policies in force. Where the policy is connected with a mortgage a trust will not be appropriate.  This is true whether the lender requires the policy to be assigned to them, deposited with them, or left with you.  This is because the proceeds of the policy will be required by your executors to repay the outstanding mortgage.
  • Single premium life assurance bonds – These go by various names such as Investment Bonds, Distribution Bonds and With Profit Bonds.  It is unlikely that a trust would be appropriate if you wish to retain the benefits arising under the policy. It makes no difference whether the policy is on a single life or joint life basis, or in the latter case, whether the policy is on a ‘first death’ or ‘second death’ basis. If, however, it is your intention to make a gift of either the policy itself, or the growth in value of the policy, to some other person then putting it under trust would be appropriate.
  • Single premium protection policy – Although not very common, some protection policies, particularly flexible whole of life policies, are set up with the payment of one premium only.  Unless such a policy is written on a ‘life of another’ basis then it should normally be written under trust.  This will avoid any potential charge to Inheritance Tax on the policy proceeds or any delay in payment of the policy proceeds on death.  If, however, the premium is particularly large so that it cannot be covered by the use of one or more Inheritance Tax exemptions, it will have to be treated as a potentially exempt transfer (PET) or chargeable transfer (depending on the type of trust used) and possibly suffer Inheritance Tax if death occurs within seven years.

General comments

  • If you have a life insurance policy leaving the benefits to your spouse or partner it would normally be appropriate for both you and your spouse or partner to be trustees.  It would be sensible to have a third trustee to cover the position if both of you died together.  A trustee should ideally be no older than you (as you do not want him or her to die before you) and should be accessible in the event of your death.  It makes a lot of practical sense to appoint a trustee who is also an executor of your will.
  • A trust is not required where the policy is issued on the life of another person.
  • Where a policy is issued on a ‘joint life first death’ basis the proceeds will pass automatically to the survivor if no trust is created.  The deceased’s interest in half of the policy will still require reporting for probate reasons but no Inheritance Tax liability will arise if the policy proceeds become payable to a surviving spouse (unless he or she is not domiciled in the UK).
  • Policies that include a critical illness benefit need special care to avoid the automatic payment of critical illness benefit to the trustees.  A ‘split trust’ can be used with such a policy so that any critical illness benefit is paid to the proposer but any death benefit is payable to the trustees.

Trust documents

Many draft trust documents are offered by life assurance companies.  This has proved to be a very helpful and highly valued service. 

Such documents are offered for no fee and are therefore not in breach of the law.

 

Important

This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.

Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe my interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.

If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.