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Should you put your life insurance in trust? The pros and cons

There are many things you need to consider with your finances, but one of the biggest is who will receive your life insurance payout and how they will receive it without incurring a hefty inheritance tax bill. 

One way to do this is by putting your life insurance in trust.  

This article looks at what this is, how it works and what you should consider beforehand. 

Summary 

  • Life insurance in trust can give you more control over your life insurance payout and help your beneficiaries legally avoid paying inheritance tax.

  • It can also offer a quicker payout as you won’t have to go through a potentially lengthy probate process.

  • There are many pros and cons to life insurance in trust, so seeking financial and legal advice is recommended.

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Life insurance and trusts: what are they? 

Before we cover life insurance in trust, it’s important to outline what a trust is and how life insurance works

A trust is when you give your assets to a dependable individual or company so they can look after them for another person, such as your children.  

Life insurance offers your dependents or beneficiaries financial support when you die, either by paying out a lump sum or regular payments.  

How much they receive depends on your policy.  

You can also choose to use the money as you wish, including to cover a mortgage or leave it as an inheritance.  

What is life insurance in trust? 

Setting up life insurance in trust can be hugely beneficial as it gives you more control over your life insurance payout. 

As you essentially transfer the legal ownership of your life insurance to trustees, it is not seen as part of your estate.

Your estate is the collective sum of your net worth and includes your property, money, investments and life insurance payouts, as well as any outstanding debt. 

By opting for life insurance in trust, your beneficiaries won’t have to pay inheritance tax on the life insurance payout.  

As you usually pay 40% inheritance tax on your estate if it’s worth more than £325,000, it’s easier than you think to exceed this threshold when you take into account any life insurance payouts.  

How does life insurance in trust work? 

If your life insurance is in trust, when you die, your trustees will take care of the policy and ensure any payout goes to your beneficiaries. 

Your beneficiaries can be whoever you want, such as your spouse or partner, children or other relatives, close friends or a charity. The beneficiary usually has to be over 18 to get money from a trust.  

You can have flexibility in how the payout is handled, as it doesn’t necessarily have to be when you die.

For example, if you choose to give your payout to your children, you could specify a specific age at which they can receive it.  

As mentioned, a big advantage of using life insurance in trust is that your beneficiaries won’t have to pay inheritance tax on the payout

Another benefit is that they should receive the money quickly, in only a few weeks, compared to going through the probate process, which can take months. 

How do you set up life insurance in trust? 

Your life insurance provider may be able to write your insurance in trust when you buy a policy. If you already have a policy, you can ask your provider if you can make the amendment.  

You’ll need to understand how your trust works, and it’s strongly advised that you get advice from a financial adviser or a solicitor.  

Unbiased can quickly connect you to a financial adviser who is regulated by the Financial Conduct Authority (FCA) and may be able to help you set up a trust. 

For a trust, you’ll need at least two trustees, such as family members who are over the age of 18 and are reliable. Alternatively, you can use a reputable company such as a bank. 

If you’re choosing people you know, you should ask them if they’re happy to be a trustee and if they fully understand their responsibilities.

The trust deeds with life insurance must be signed by everyone involved, and the trustees will then be in charge of it. 

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What are the different types of trusts for life insurance? 

If you’re considering setting up a trust, there are a few to choose from, so it’s worth understanding how they work. 

Below are some examples of trusts for life insurance: 

An absolute or bare trust 

Any assets in an absolute trust (also known as a bare trust) are held in the name of trustees, but the beneficiary can access capital and income if they’re 18 or over in England and Wales or if they’re 16 or over in Scotland. 

It’s worth noting the beneficiaries cannot be changed with an absolute trust.  

Discretionary trust 

Trustees can decide how to use the income and sometimes the capital, including what gets paid out, which beneficiaries to make payments to, the frequency of payments and any conditions. 

Discretionary trusts can be useful for beneficiaries who may not be capable of handling their money. You can write a ‘letter of wishes’ to help your trustee make payout decisions.  

Beneficiaries can be added and changed to a discretionary trust.  

Flexible trust 

With a flexible trust, your chosen beneficiary gets the life insurance payout when you die.  

You can decide how you want the money to be distributed. 

Split trust 

Here, you can separate life insurance and critical illness policies so you can get the illness payout without impacting the money from life insurance (this will continue to be managed by trustees).  

Survivor’s discretionary trust 

This can be useful for cohabiting couples with joint life insurance – if your partner dies, you inherit the life insurance payout before other beneficiaries (and vice versa). 

The payout will go to other beneficiaries if you both die within 30 days of each other.  

A survivor’s discretionary trust also means unmarried couples can avoid inheritance tax as the life insurance payout is not viewed as part of either partner’s estate.  

What are the pros and cons of setting up a life insurance in trust? 

There are many advantages and disadvantages to consider before writing a life insurance in trust. 

Pros: 
  • No inheritance tax: Your life insurance payout is protected from inheritance tax. 

  • Quicker payouts: As you don’t need to wait for probate, which can take many months, any money from the life insurance policy can quickly be paid out.  

  • It’s usually free to set up if you have a trust: Many insurance providers will help you set up life insurance in trust for free, but it’s worth checking first.  

  • Your insurance money is usually paid according to your wishes: Not only can you choose your beneficiaries and how they receive the money, but it cannot be used to clear any debt.  

Cons: 
  • No control over your life insurance: As you’re handing over the legal ownership of your life insurance in trust to a trustee, you’ll have no control. This decision is irreversible. 

  • Legal and tax implications: When you set up a trust, there are many legal and tax implications to consider, and you can’t change your mind. So, it’s vital that you get legal and financial advice beforehand on whether life insurance in trust is right for you.  

  • Risk of invalidating insurance: There may be rare circumstances when you can amend a trust, but you can end up invalidating your life insurance.  

  • Watch out for the seven-year rule: If you change your beneficiary and pass away less than seven years later, or if your new beneficiary isn’t a spouse or civil partner, inheritance tax may be due. 

Should I get life insurance in trust? 

Whether you should set up life insurance in trust depends on many factors. 

For example, if your estate is likely to be subject to inheritance tax, it’s worth considering – unless you’re leaving your estate to your spouse or civil partner.  

A financial adviser and solicitor can be helpful in figuring out whether life insurance in trust is worthwhile for your situation.  

Considering setting up life insurance in trust? 

Unbiased can help quickly match you with a qualified financial adviser who can help you decide whether writing life insurance in trust is best for your unique circumstances. 

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About the author
Lisa-Marie Voneshen is a Senior Content Writer at Unbiased. She is an award-winning journalist with nearly a decade of experience writing and editing content across various areas, including personal finance and investing.