When someone dies, their life insurance payout does not always reach their family quickly or in full. If the policy forms part of the deceased’s estate, the proceeds may be subject to inheritance tax and could be delayed by the probate process. Writing life insurance in trust is a legal arrangement that can address both of these issues. This article explains what placing a policy in trust involves, how it affects inheritance tax in the UK, and which types of trust are commonly used.
What Does It Mean to Write Life Insurance in Trust?
Writing a life insurance policy in trust means legally transferring ownership of the policy from the policyholder to a trust. A trust is a legal arrangement where assets are held by appointed trustees on behalf of named beneficiaries.
Once a policy is placed in trust, the payout no longer belongs to the policyholder’s estate when they die. Instead, the trustees manage the proceeds and distribute them according to the terms of the trust.
This arrangement is separate from the insurance policy itself. The policy terms, premiums and sum assured remain unchanged. What changes is who legally owns the policy and who controls the payout after a claim.
How Inheritance Tax Applies to Life Insurance Without a Trust
In the UK, inheritance tax (IHT) is charged at 40% on the value of an estate above the nil-rate band, which currently stands at £325,000. There is also the residence nil-rate band of up to £175,000 for those leaving a home to direct descendants.
If a life insurance policy is not written in trust, the payout is added to the value of the deceased’s estate. For larger estates, this can push the total above the IHT threshold, meaning a significant portion of the payout could be lost to tax.
Writing the policy in trust removes the payout from the estate entirely, provided the trust was set up correctly and the premiums paid did not count as chargeable transfers under HMRC’s rules.
How Writing in Trust Speeds Up the Payout
When a life insurance payout forms part of an estate, it cannot be released until the probate process is complete. Probate can take several months, and in complex cases, considerably longer.
A policy held in trust bypasses probate entirely. The trustees can make a claim directly with the insurer and distribute the funds to beneficiaries without waiting for a grant of probate. For families who rely on the payout to cover immediate costs such as funeral expenses or mortgage payments, this can make a significant practical difference.
Types of Trust Used for Life Insurance Policies
There are several types of trust that can be used when placing a life insurance policy in trust. The most common options in the UK are outlined below.
Absolute trust (also called a bare trust)
- Beneficiaries are named at the outset and cannot be changed
- Beneficiaries have an absolute right to the trust assets once they reach age 18 (or 16 in Scotland)
- Simple to set up and administer
- Suitable when the policyholder is certain about who should receive the payout
Flexible trust (also called a discretionary trust)
- Trustees have discretion over who receives the payout, when and how much
- Beneficiaries can be added or removed
- More complex to administer
- Useful when family circumstances may change, for example if children are young
Split trust
- Used when a policy combines life insurance with critical illness cover
- The life cover element and the critical illness element are split between the policyholder and the trust
- This allows the policyholder to receive a critical illness payout during their lifetime while keeping the life cover in trust
Each type has different legal and tax implications, and the right choice depends on individual circumstances. Anyone unsure which trust type is appropriate should seek independent financial advice from a regulated adviser.
How to Place a Life Insurance Policy in Trust
Most UK life insurers provide trust forms as part of the application process, often at no additional charge. Setting up a trust typically involves:
- Completing the insurer’s trust deed or nomination form
- Choosing the type of trust
- Naming trustees (at least two are usually recommended)
- Naming beneficiaries or a class of beneficiaries
- Signing and witnessing the trust document
For new policies, the trust can usually be established at the same time as the policy is set up. Existing policies can also be placed in trust, although this may have different tax implications. HMRC may treat transferring an existing policy into trust as a chargeable lifetime transfer if the policy has a surrender value at the time of transfer.
Choosing Trustees and Beneficiaries
Trustees are the individuals responsible for managing the trust and distributing the payout. Some key points to consider include:
- Trustees must be over 18 and of sound mind
- It is common to appoint at least two trustees
- The policyholder can be a trustee, but should not be the sole trustee
- Trustees should be people the policyholder trusts to carry out their wishes
Beneficiaries are those who will ultimately receive the payout. Under a flexible trust, the trustees decide how to distribute the funds. Under an absolute trust, the named beneficiaries have a fixed legal right to the proceeds.
Which Policies Can Be Written in Trust?
Most types of personal life insurance policy can be placed in trust. This includes:
- Level term insurance, where the payout remains the same throughout the policy term
- Decreasing term insurance, where the payout reduces over time, often used alongside a repayment mortgage
- Whole of life policies
- Over 50s life insurance plans, although some providers handle trusts differently for these products
- Joint life insurance policies
Policies provided through an employer, such as death in service benefits, are usually already held in trust by the employer’s pension scheme or group life scheme. Relevant life insurance, which is a tax-efficient policy arranged by an employer for an individual employee, is also typically written in trust from the outset.
Income protection policies pay out to the policyholder during their lifetime and are not usually written in trust, as the benefit is designed to replace the policyholder’s own income.
Potential Drawbacks and Considerations
While placing a policy in trust has clear advantages, there are some important points to be aware of:
- Once a policy is in trust, the arrangement generally cannot be reversed or easily amended, particularly with an absolute trust
- Changes in family circumstances, such as divorce or the birth of additional children, may not be reflected in an absolute trust
- Flexible trusts may be subject to periodic charges and exit charges under HMRC’s relevant property regime, although for most life insurance trusts the amounts involved are below the thresholds that trigger these charges
- Transferring an existing policy with a surrender value into trust may count as a chargeable lifetime transfer for IHT purposes
- Trusts must comply with HMRC’s Trust Registration Service (TRS) requirements, which may involve registering the trust online
Frequently Asked Questions
Does writing life insurance in trust cost anything?
Most UK insurers provide trust documentation at no extra charge as part of the policy application. However, if a solicitor or financial adviser is involved in setting up a more complex trust arrangement, there may be professional fees.
Can I change the beneficiaries after setting up a trust?
Under a flexible or discretionary trust, the trustees can add or remove beneficiaries. Under an absolute trust, the beneficiaries are fixed and cannot normally be changed once the trust is established.
Is a life insurance payout in trust always free from inheritance tax?
Not necessarily. If the premiums paid into the policy exceed HMRC’s annual gifting exemptions (currently £3,000 per tax year) and the policyholder dies within seven years, HMRC may include part of the premiums in the IHT calculation. For most standard term life insurance policies where premiums are paid from normal expenditure out of income, this is unlikely to be an issue.
Do I need a solicitor to write a policy in trust?
For straightforward trusts using an insurer’s standard trust forms, a solicitor is not usually required. For more complex estates or trust arrangements, legal advice may be beneficial.
What happens if all named trustees die before the policyholder?
If all trustees die or become unable to act, new trustees need to be appointed. It is advisable to review trustee arrangements periodically and consider naming replacement trustees where the trust deed allows.
Sources
- GOV.UK, Trusts and taxes
- GOV.UK, How Inheritance Tax works: thresholds, rules and allowances
- GOV.UK, Register a trust as a trustee
- MoneyHelper, Should I put my life insurance policy in trust?
About the Author
Tanweer Hussain is the editor at TopQuote.co.uk. He oversees the editorial accuracy of all published content, with a particular focus on the factual detail relevant to UK protection insurance. TopQuote is authorised and regulated by the Financial Conduct Authority.
This article is intended for general information purposes only and does not constitute financial advice. Your individual circumstances will affect which options may be available to you. TopQuote.co.uk is a comparison and information service, not a financial adviser. Always seek independent financial advice from a regulated adviser before making any financial decisions.