Writing life insurance in trust

What is a trust?

A trust is a legal arrangement that allows you to transfer the money payable from your life insurance policy to people, or a company, who will act as trustees.

Your trustees could be family members or friends, or a solicitor. They will have the role of looking after the funds for the people you’ve named as your beneficiaries.

Your trustees are legally responsible for making sure your life insurance payout is distributed and paid to those exactly as you’ve instructed.

Why is writing life insurance into trust so important?

Writing life insurance into trust is a way of helping the people you leave behind to access the money as quickly as possible, by not having to wait for probate to be granted.

By keeping the life insurance payout separate from your legal estate (everything you own at the time of your death) it can also reduce the amount of inheritance tax you pay.

How does putting life insurance in trust work?

Usually, insurers give you the option of writing your policy into trust when you take out life insurance.

You may also be able to transfer an existing policy into trust, but it’s likely you’ll need to use a solicitor to help you do this.

Setting up a life insurance policy written into trust requires the following people:

• Settlor – the person who’s putting their policy into trust and who’s responsible for paying the policy premiums
• Beneficiaries – one or more people chosen by you, the settlor, to receive a payout from the trust if you die during the policy term
• Trustees – usually two or more people that, as the settlor, you pass legal ownership of the trust to. They’ll be responsible for looking after the insurance funds for your beneficiaries and are legally obligated to fulfil your wishes

Once your policy’s written into trust it’ll be your trustee’s responsibility to make the claim to your insurer when you pass away and to distribute the money to your beneficiaries.

As the policyholder, you’re responsible for keeping up the payment of your life insurance premiums during your policy’s term to make sure it stays valid.

Who can be a beneficiary?

You can choose anyone to be your beneficiary - the person or people who’ll receive the lump sum paid out by the insurance company in the event of your death. 

A beneficiary doesn’t have to be a spouse or a partner, it can be a relative, friend, or anyone you’d like to help financially once you pass away. You can also leave money to organisations like charities.

If you have more than one beneficiary, you’ll need to decide what portion each will receive. For example, you might allocate 50% to your spouse and give your two children 25% of your estate each.

You should also consider whether receiving the money could negatively impact their financial situation, like affecting any means-tested benefits they qualify for. 

Who can be a trustee?

The trustees are a group of people chosen by you to look after and manage the money in the trust, according to the rules in the trust document. 

Typically, as the settlor, you will also be a trustee and this can help you to keep some control.

A trustee can be anyone over the age of 18, who doesn’t have a criminal record or any history of bankruptcy, even if they’re also a beneficiary under the trust.

It’s normal to appoint at least two trustees and they’ll make decisions about the trust collectively. Depending on the terms of the trust, their duties may involve deciding who should benefit (from the list of beneficiaries) and when they’ll be paid.

What are the main types of life insurance trust?

When you’re looking at options for life insurance trusts, you’ll need to decide which will be the right type for you.

There are two main types of life insurance trust:

Discretionary trust

This type of trust provides some flexibility – the settlor can put together a list of potential beneficiaries, which can be added to or changed during the policy term.

The trustees have total discretion for which beneficiaries will receive money from the trust and the portion they receive. 

So it’s usual for the settlor to provide the trustees with a letter of wishes to give some guidance on their original intentions for the trust. 

Absolute trust

Also known as a bare trust, this is the simplest type of trust – but it’s also the most rigid.

Once set up, it’s not possible to add to, or change the list of beneficiaries or how much each will receive. 

But it does mean the settlor decides who receives the money and no one else can change this. The beneficiary has an automatic right to the money in trust once they turn 18 years old.

What are the advantages of putting life insurance into trust?

There are many reasons why you might choose to write your life insurance into trust, these include:

• Helping to reduce your liability for inheritance tax – any life insurance money paid out won’t be considered as part of your estate, so won’t be liable for any inheritance tax
• Giving you more control – it helps to ensure the money is shared out and used how you want it to be. And it means the insurance payout may be protected from creditors and anyone with a claim on your estate
• Quicker access to your money – By the money not being part of your estate, it doesn’t need to go through probate, so your beneficiaries can receive the payout much more quickly

Are there disadvantages?

There are some other factors you should also consider when you’re looking into life insurance written into trust:

• You can’t change your mind – once your policy is written into trust it’s under the control of the trustees and this can’t be undone
• It can be difficult to make changes – certain trusts don’t allow for a change in circumstances, for example, if you wanted to remove beneficiaries or add new ones
• Your trustees can have the final say – depending on the type of trust, and although you can leave guidance, your trustees ultimately decide how the money is managed

Can a joint life policy be written in trust?

Yes, it’s possible to do this, but it can be less necessary when the couple is married. This is because a joint life policy payout will automatically go to the surviving spouse or civil partner, and will be exempt from inheritance tax.

However if, as married policyholders, you both die at the same time and don’t have a will, having a joint policy in trust can ensure you have control over who receives the payout.

But be aware that when a joint life policy is written in trust, it will only pay out once and then the policy ends. This means the surviving partner will be left without life cover.

An alternative option is for both spouses to take out a single life policy. This means that when one of you dies, a payout is made, while the surviving spouse’s life cover continues.

What about cohabiting couples?

A joint life policy in trust can be a good idea for couples who aren’t married, or who don’t have a civil partnership. 

This is because if the policy’s not written into trust, where the beneficiaries are specified, the insurance benefit will be paid to the closest family member and not the cohabiting partner.

How long does a trust last?

A life insurance trust can exist for up to 125 years, but typically your trust agreement will last for however long you decide is necessary when you set up your policy.

For example, if your beneficiaries are children, you may choose a period of time that will mean your trustees will manage the funds in the trust until your children reach a certain age.

Are life insurance payouts taxed?

The payouts from life insurance aren’t usually subject to tax. Neither capital gains nor income tax is applicable here, so your beneficiaries will usually receive the money in full.

But if the insurance payout is added to your estate and the value of your estate is over the inheritance tax threshold (usually £325,000), anything over this amount will be subject to 40% tax.

When the assets of your life insurance are put into trust, they’ll be kept separate from your estate and won’t be subject to any inheritance tax if your estate is above the threshold.

However, if a policyholder moves their life insurance policy into trust or makes changes to the beneficiaries within seven years of dying, inheritance tax could be charged.

Can I change my life insurance policy after it has been written in trust?

It’s very difficult to make any changes once you’ve written your policy into trust. This is because once your policy’s in trust it’s then under the control of the trustees – and it usually can’t be taken out of trust again.

Making any changes to the policy could even mean that you unknowingly invalidate it.

So before you set up your policy in trust, make sure you’re confident that you’ll have enough cover and will be unlikely to make any changes to it in the future.