Nobody likes to think about passing away - especially when we’re all too busy living, right? The fact remains, however, that the unexpected can come sooner than we think, which is why it’s so important to plan ahead and make sure that you’re prepared for whatever life throws your way - good or bad.
You may have come across the word ‘trust’ before when considering how you will pass on your possessions to your loved ones, and trusts are also very relevant to life insurance.
Life insurance exists to make sure that those you hold dear are taken care of, should the worst happen, ensuring that they get more than just your (albeit very treasured!) stamp collection. In short, life cover will pay your loved ones a lump sum of tax-free money when you (the policyholder) pass away.
Here are the three main reasons people choose to put their life insurance policy in a trust (don’t worry, we will explain all of these in more detail!):
The payout may not be subject to inheritance tax
Trusts can make it easier for your loved ones to access your life insurance money more quickly by avoiding a thing called probate
The payout is better protected from creditors - it won’t automatically be used to pay off debts
This guide will explain what a trust is, how you can put a life insurance policy in trust and why you might want to do so. To give you fair warning, trusts can get a little technical (not to mention attracting some pretty hefty jargon) but fear not, this guide will go through it all step-by-step and make sure every term is made crystal clear. If you’ve still got questions after taking a read, feel free to give us a call on 03456 442 540 for an extra helping hand! Oh, and it’s also worth checking out our write your policy in trust page.
What is a trust?
Before we jump in, let’s make sure we are clear on some of the technical lingo. The things that you own (including property, land, financial assets and your life insurance policy - if you have one!) are known as ‘assets’, and the sum of all your assets together is called your ‘estate’. The people who you specify that you would like to receive your assets or your estate, usually your loved ones, are called your ‘beneficiaries’.
A trust, in very basic terms, is a legal arrangement that leaves your assets, including your life insurance policy, in the hands of a trusted person or trusted people. These people - aptly named the ‘trustees’ - look after those assets, including your policy when you pass away and ensure that any payout is divided out between your loved ones (your beneficiaries) at the appropriate time, according to your wishes.
Your trustees could be family members or friends, or you could choose to have a legal professional oversee your trust. The same person can be both the trustee and the beneficiary, providing they are over 18 and have the mental capacity to do so. People often choose to name their children as beneficiaries, in which case the trustee must be someone different (and over 18), who would look after your assets until the child comes of age.
How trusts work for life insurance
But let’s zoom in a little now on life insurance and trusts. As we have already mentioned, you can put your life insurance policy into trust. Basically, this means that, once the trust is set up, the named trustee will legally own your life insurance cover.
It’s important that the trustees keep the trust paperwork - called the ‘deed’ - safe, as they will need that paperwork to claim the payout from your life insurance policy should you pass away. The deed outlines the terms of the trust, ensuring the payout is used exactly as you intended. Of course, it’s worth noting that once the policy is written in trust, the decision usually can’t be changed further down the line. By this we mean you usually won’t be able to pull the policy out of the trust or change the beneficiaries at a later point (though this does depend on the type of trust), so make sure you’re certain about putting your life insurance plan in trust before you do so.
Do you have to pay inheritance tax on a trust?
Taking out a life insurance policy is undeniably a great way of looking after your family’s future. However, it’s worth noting that if you don’t choose to write your policy in trust, your life insurance payout could become subject to inheritance tax. This is a tax of up to 40% on the total value of your estate, which would include your life insurance, when you pass away (remember your estate is simply the sum of all of your assets). This could mean that your loved ones receive a smaller payout than expected, though the 40% tax rate will only apply if the total value of your estate is worth over a certain amount (usually £325,000*).
In short, if you think that the value of your estate (including your life insurance plan) could leap over this threshold, then putting your life insurance cover in trust can save your loved ones a fair chunk of money that would otherwise go to the taxman.
Should I put my life insurance policy in trust?
Putting your life insurance into trust is a popular option that comes with many perks. As we have mentioned, it could save your loved one from having to pay inheritance tax on the payout, but that’s not the only benefit.
In many ways, writing your life insurance policy in trust puts you in the driving seat. You can choose who to appoint as your trustee(s) and who to name as your beneficiaries, so you have full control over who receives the policy payout. On top of that, if you have any outstanding debts still to pay when you pass away, you can be confident that by locking away your life insurance plan in a trust, you’re protecting the payout and ensuring it goes to your loved ones, rather than to pay your debts off.
Putting your life cover plan in trust also means your loved ones get their payout quicker should the worst happen and you pass away. When life insurance is written in trust, your trustee is required to present less paperwork - they just need your death certificate to make a claim. It also means you avoid a process called ‘probate’, where the court gets involved in dividing your assets, which can be a lengthy process, and one your family probably wants to avoid.
Ultimately, having a trust in place can knock down a number of hurdles, meaning that your life insurance policy payout can happen with far more haste, potentially in a matter of weeks rather than months. You can read our ‘How does my family get my life insurance payout?’ guide for more detail.
One thing to bear in mind is that trusts do come into play as soon as they are set up, meaning that the trustees you name will have ownership of the assets in the trust while you are still alive. You can name yourself as a trustee, which means you retain some control, but any decisions would need to be signed off by all of the trustees. The other thing that can put people off is that a trust is irreversible - once it is in place, it cannot be removed or dismantled. This means it is not a decision that should be taken lightly, but instead be well thought through.
If you are unsure whether writing your life insurance policy in trust is the right option for you and your loved ones, you can get some help from one of our insurance specialists by calling 03456 442 540 or you can contact a legal professional who will also be able to advise you.
What types of trust are there?
There are a number of different trust options you can choose from, with three of the main ones being discretionary, flexible and absolute trusts. The crucial difference between them comes down to flexibility, as discretionary trusts and flexible trusts allow for much more wiggle room than absolute or bare trusts.
For example, a flexible or discretionary trust could give you the option of adding further beneficiaries after the trust has been set up. By contrast, beneficiaries chosen in an absolute trust can’t be changed down the line, making it the ideal option for anyone certain who they would like to receive the payout, come hell or high water! Put simply the beneficiaries named are ‘absolutely’ entitled to their share of the payout.
With a discretionary trust, you would typically name a wide range of potential beneficiaries, then leave it to your trustee to manage which of these will receive a benefit from the policy and how much each person would get. This set up therefore puts more responsibility on the trustee, and for that reason will appeal to some more than others. If you did decide to use a discretionary trust, then it may be a good idea to choose a legal professional to be your trustee. You can also complete a ‘letter of wishes’ along with this type of trust to give your trustee some guidance (though please note that a ‘letter of wishes’ in this context is not legally binding).
If you were not keen on this approach, then you may want to opt for a flexible trust instead, which is very similar to a discretionary trust, but gives you the ability to name exactly who you would like to benefit from the payout and how the money would be distributed.
We appreciate that there is a lot to digest here! If you’re unsure about any of the trust options on offer, or whether setting up a trust is the right move for you, we’d very much suggest getting in contact with a legal professional or your solicitor.
How do I put my life insurance policy in trust?
Usually, when you first go to purchase your life plan from an insurer, they will give you the option of writing the policy in trust, so it helps to have decided whether you want to do so, and have your trustees in mind, before you get to this point.
That said, you can also decide to put your life insurance plan into trust at a later date, if you are unsure at the point of purchasing the policy. You may need the help of a financial adviser or solicitor to get this all set up for an existing policy, though.
Ultimately, if you value your main assets (e.g. property, finances, that stamp collection!) enough to put them in a trust, you should consider doing the same with your life insurance policy. But trusts are not right for everyone. As always, when it comes to life insurance, the most important thing is to consider all your options and make the right decision for you and your family. Here at Cavendish, we can help you cover all the bases with expert advice and support. You can get in contract with us on 03456 442 540.
*Inheritance tax rules based on the 2021/22 tax year
