Inheritance Tax (IHT), Estate Planning and Life Insurance

It's possible to avoid your family being charged inheritance tax (IHT) on the benefits from your life insurance policy if you put it into a trust.

Life insurance pays out money to your family after your death. In the UK, there is no inheritance tax payable if the total value of your estate is less than £325,000.  ("Estate" simply means everything you own at the point that you pass away.)

But if the value of your estate is more than £325,000, inheritance tax will be charged at 40% on everything above that threshold – including life insurance pay outs.

If you’re worried about your family having to pay IHT on your life insurance, you can take out the policy in trust. There are legal fees to pay, so it's not for everyone, but it can bring advantages when it comes to estate planning.

In this short guide we'll cover:

• What is a life insurance trust?
• How to put a life insurance policy in trust
• Who should you name as a trustee?
• How does a life insurance trust affect your beneficiaries?
• Are there any drawbacks to putting life insurance in trust?
• Is putting your life insurance in trust right for you?

What is a life insurance trust?

A life insurance trust is a legal arrangement which means the policy is owned by trustees, rather than by yourself.

This means that when you die, the pay out can go directly to your beneficiaries, rather than being included as part of your estate. As a result, your family won’t pay inheritance tax on the money.

If you’re thinking about putting a life insurance policy where your spouse or civil partner is the beneficiary, there’s no need to worry about the money being treated as part of your estate. Under the spousal exemption, they can inherit your estate without any inheritance tax being due, as long as they’re a UK resident,

How to put a life insurance policy in trust

You can take out a brand new life insurance policy with a trust from the start, or you can put an existing policy into a trust.

If you’re putting an existing policy in trust, you’ll need to set up a trust with your life insurance provider. The provider will then issue a new policy schedule, which will have the trustees’ names on it.

Your existing policy will be cancelled and you’ll have to make sure you pay the premiums on the new policy. You’ll also have to make sure you communicate the existence of the trust to your beneficiaries. (By "beneficiaries", we mean the people who you've stipulated that the life insurance money should be paid out to).

Who should you name as a trustee?

You can name anyone you like as a trustee, but most people choose an adult relative or a trusted friend.

You can also name a professional trustee, such as a solicitor or accountant, but there will be a charge for this.

How does a life insurance trust affect your beneficiaries?

Putting your life insurance in trust means your beneficiaries will receive the life insurance pay out directly, rather than through your estate. This can help if – for example – you owe money to creditors, as it will enable them to pay off the debt more or less immediately. (You can read about the timelines for life insurance payouts here.)

If you’re putting life insurance in trust for your children, they will also be affected by how you decide you want the money to be paid out.

If you set up a so-called bare trust, your beneficiaries will receive the money automatically, which may be before they have the financial knowledge to manage the money responsibly.

Alternatively, you can set up a discretionary trust. In this scenario, the trustees will have the power to decide when and how much money is paid to your beneficiaries. This means they can decide if it’s in your beneficiary’s best interest to receive the money in one lump sum when they reach 18, or if it would be better to receive it over time.

It’s important to be clear about your wishes with your trustees, as the decisions they make will affect how your beneficiaries receive the money.

Are there any drawbacks to putting life insurance in trust?

There are indeed some drawbacks to putting your life insurance in trust:

• You are likely to incur legal fees for setting up the trust
• There is a fair amount of legal paperwork to do, which can be time-consuming
• When you put your life insurance in trust, you’re no longer the owner of the policy and you can’t cancel or change it without the trustees’ permission

Is putting your life insurance in trust right for you?

Putting your life insurance in trust can provide peace of mind that your loved ones will receive the money you want them to.

However, it’s important to be aware of the potential implications of putting your life insurance in trust before you decide whether it’s the right thing for you.

If you’re not sure, speak to a financial adviser. They can help you understand the pros and cons and make the best decision for you.