Putting Life Insurance In Trust (An In Depth Guide)
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How and Why to Place Life Insurance in a TrustIf you own an individually purchased life insurance policy, you may be wondering if it makes sense to place the policy into a trust. Putting life insurance in trust can provide valuable benefits relating to control of the proceeds and inheritance tax planning. This guide will explain how setting up an appropriate trust works in the UK and what the key advantages are.
What is a Trust?A trust is a legal arrangement where assets are put under the control of assigned trustees for the benefit of chosen beneficiaries. The trustees manage the assets on behalf of the beneficiaries based on the trust terms.There are many types of UK trusts but those most relevant for life insurance include bare (absolute), discretionary and flexible trusts. With an insurance trust, you name trustees to manage policy payouts to beneficiaries you select. This transfers control from you to the trustees upon your death.
Why Put Life Insurance in Trust?Placing a life insurance policy into an appropriate trust offers several advantages:
- Speeds up payouts – Bypasses probate so proceeds reach beneficiaries faster.
- Avoids inheritance tax – Trust assets are excluded from your taxable estate.
- Maintains privacy – Keeps policy details and payouts private, unlike directly named beneficiaries.
- Specifies payout use – Trust terms direct how proceeds are utilized by beneficiaries.
- Control over time – Assets are managed by trustees rather than released immediately.
- Protection from creditors – Trust assets are not vulnerable to beneficiary’s creditors.
- Guardianship of minors – Trustees manage assets on behalf of minor children until adulthood.
- These benefits ensure your policy provides for loved ones as intended. The trust structure safeguards the proceeds.
How to Place Life Insurance in a TrustIf you decide to put a life insurance policy in trust, below are the steps involved:
- Choose trustees – Select trustees to manage the policy payout for beneficiaries. Requirements vary but trustees must be UK residents over age 18. Consider competence and relationship.
- Pick beneficiaries – Determine who should receive proceeds from the trust – children, spouse, charity etc. Can name primary and contingent beneficiaries.
- Decide on trust type – Common choices like bare, discretionary and flexible trusts have different control levels. Requires legal input.
- Create trust deed – A deed outlines trust terms and parties involved. Prepared by a solicitor. The deed can be amended.
- Transfer policy to trust – Work with the insurer to assign the existing policy to a chosen trust and name trustees as owners.
- Notify beneficiaries & trustees – Make all parties aware of their roles. Provide trust documentation.
- Upon death – Trustees will claim proceeds and distribute them to the beneficiaries as per the trust rules.
- Properly structured, the trust provides control over policy proceeds. Trustees are bound to follow the terms.
What Trust Type is Best?Common options like bare, discretionary and flexible trusts have pros and cons to weigh when deciding what works for your situation.
- Bare (Absolute) Trusts – Beneficiaries and share amounts are fixed. Beneficiaries must be over 18. The oldest type of trust.
- Discretionary Trusts – Trustees have discretion over which beneficiaries receive proceeds and amounts. Flexible but less control.
- Flexible Trusts – Hybrid approach where some beneficiaries are fixed and others discretionary. Added flexibility.
Using Trusts for Inheritance Tax PlanningInheritance tax planning on life insurance payouts is a major reason for placing policies into trusts. Trusts can minimise inheritance tax liability in several ways. First, life insurance proceeds are usually excluded from inheritance tax calculations, provided the policyholder and beneficiaries are separate persons. This is the case when you directly name individual beneficiaries on the policy.However, the tax-free treatment changes if beneficiaries are not separate individuals and instead are immediate family members. In that case, the proceeds from a personally owned life insurance policy would be counted as part of your taxable estate for inheritance tax purposes after your death.By transferring your policy to an appropriate trust where trustees manage payouts to beneficiaries, the death benefit can remain exempt from inheritance tax even when passing funds to non-separate beneficiaries like children or a spouse.Trust structures make the payout tax-free regardless of who ultimately receives the money. This sheltering applies even if proceeds are large enough to surpass the standard inheritance tax thresholds or nil-rate bands.For married couples in particular, using insurance trusts allows full utilization of the inheritance tax allowance for both deaths. Without trusts, there is a risk of life insurance payouts being taxed if both spouses were to pass away within a short timeframe. The proceeds from the first death reduce the available threshold, and proceeds from the second death fall into taxable territory.Trusts avoid this issue by effectively earmarking the tax-free inheritance amount on each death. This allows more of the estate to be passed on tax-free and as intended.Overall, placing life insurance in an appropriate trust provides you with more control over inheritance tax exposure. Trusts make policy proceeds exempt regardless of amount or timing.
Disadvantages of putting life insurance in Trust?While utilizing trusts to manage life insurance payouts provides significant benefits, there are some potential disadvantages of putting life insurance into a trust. First, there are usually upfront legal costs to establish an appropriate trust deed and structure. Solicitor fees apply, so there is some initial expense.Ongoing administrative duties also fall to the trustees in managing trust assets and distribution to beneficiaries. This responsibility lasts until assets are fully distributed. So there are some recurring administrative burdens.Transferring a policy to trustees means you relinquish direct control over the assets and any payouts. The trustees assume full authority per the trust terms. So you have less say once the trust is operative.Complex trust structures, especially discretionary trusts, can also create friction between beneficiaries if disputes arise. Not all beneficiaries may agree with distribution decisions.Beneficiaries also do not directly own or control the assets in the trust. The trustees manage the assets on their behalf.Finally, once a trust is established it can be quite rigid and inflexible if situations or goals change. Amending trusts is difficult compared to altering a will.Carefully weighing these pros and cons allows you to determine if the benefits outweigh the modest added responsibilities and loss of control over your situation. For many, the tax and probate advantages make trusts worthwhile despite the small tradeoffs.
Jody is the Managing Director and founder of My Key Finance Ltd. He has over 16 years experience as a protection adviser and is an authority within the UK business protection market. Jody has written articles for Business Matters Business Directory, and been featured in Forbes. As editor and Author of our blog Jody is hoping to educate and advise people with more in depth details and information on the various subject relating to the protection market.