Life Insurance and Trusts
When life insurance is put in place on the life of an individual, it is designed to pay a cash lump sum on death.
When a claim is successful, the insurer will allocate funds to the claim and, if there are no other arrangements, the funds are paid into the estate of the deceased.
This is not ideal, as in order for surviving family members or friends to benefit from the life insurance, the funds have to be moved from the estate of the deceased into the hands of the people who will benefit (beneficiaries).
This causes a number of potential issues.
Trusts, tax, and timing
Funds passing through the estate of the deceased are affected by various aspects of legislation which mean that:
Tax could be charged on the estate (inheritance tax)
- Debts owed by the deceased will firstly be paid from the estate where appropriate
- There could be multiple unresolved claims on the estate if there is no Will (intestacy)
- The process of distributing the estate can be lengthy and complicated. (This process is known as Probate in England, Wales, Northern Ireland, and Confirmation in Scotland)
Clearly, any life insurance benefits passing through the estate could be delayed or eroded as a result of these issues.
The better result would be if the proceeds of the life insurance policy went straight to the beneficiaries
- without tax
- without delay
- without fuss
this is the purpose of using a Trust arrangement in conjunction with an insurance policy.
It is known as ‘writing the policy in Trust’.
What is a Trust
A Trust is a legal arrangement that allows you to gift your assets without losing control of them.
In conjunction with your life insurance policy, a Trust can ensure that the proceeds of your policy go direct to your intended beneficiaries without delay.
The Trust can also protect against inheritance tax. It is therefore always a good idea to consider writing your policy in Trust whenever you take out a life insurance policy.
Trusts – common terms used
- Asset – an asset is any item of value, for example, a life insurance policy
- Beneficiary – the people or organisation that it is intended will benefit from the proceeds of a Trust
- Estate – anything of value owned by the deceased on death
- Inheritance Tax (IHT) – tax levied on an Estate. (In the 2013/2014 tax year, this is 40% payable on the value of an Estate over £325,000)
- Probate – applying to be able to deal with a deceased persons affairs
- Settlor – the person who creates the trust (usually the insured person and sometimes referred to on Trust forms as the donor)
- Trustee – a person appointed to be responsible for the management of the Trust
Example Trust form
Here is an example trust form as used by Legal and General. The major insurers all provide draft forms of a similar nature. Don’t worry about completing them, your protection adviser can assist you. If you do not have a protection adviser, feel free to call our team on 020 8979 9684.
Writing life insurance in Trust
All major insurers provide the necessary arrangements for a policy holder to write their life insurance policy in Trust. This service is normally free of charge.
In order to write a policy in Trust, the policy holder (Settlor or Donor for the purposes of the Trust) can be provided with standard trust forms to complete and sign. Once completed, these trust forms are noted by the insurer against the policy.
Your protection adviser can assist you with this process on new or existing policies.
Trusts and Critical Illness Cover
Many modern protection policies pay out a cash lump sum if the insured is diagnosed with a critical illness. Since this cash lump sum is claimed whilst the insured is still alive, a Trust may not be appropriate in these cases.
Critical Illness policy providers therefore often offer a specialist ‘split trust’ arrangement whereby the policy can be written in Trust with the death benefits entering the Trust and critical illness benefits (or terminal illness benefits) being paid directly to the insured.
The most common arrangement, is that the Trust in its standard form, allows for the payment of critical illness payments direct to the Settlor, but can be varied when drawn up so that critical illness benefit can enter the trust if the Settlor does not require it.
Writing a Trust – considerations
Here are a number of considerations when considering who to include in your trust.
Beneficiaries – who should benefit on your death, and in what proportion. Trust will generally list potential beneficiaries such as children or grandchildren but you may wish to be more specific.
Trustees – your Trustees ensure that the right money goes into the right hands at the right time, they are empowered to do this through your nominating them as Trustees in your Trust. A Trustee can be any adult you choose and you do not have to use a legally or financially qualified or regulated person to act as a Trustee.
It is suggested that a Trustee should be a similar age or younger than you (to reduce the chance of their predeceasing you), financially stable and responsible, and convenient to contact in the event of your death.
You should normally have a least two Trustees and one can be your spouse (but does not have to be).
Witnesses – normally when you sign a Trust as a Settlor your signature needs to be witnessed. It is recommended that your Witness is not also a Beneficiary or a Trustee under the Trust (a friend or neighbour is normally ideal).
- Discretionary Trust – under a discretionary trust the trustees can appoint from a range of discretionary beneficiaries.
- Flexible Trust – trustees can appoint from a range of discretionary beneficiaries but the Settlor has to specify at outset a default beneficiary or beneficiaries. The default beneficiaries will receive any capital from the Trust unless discretionary beneficiaries are appointed.
- Absolute Trust – at outset beneficiaries are specified by the Settlor. If more than one Beneficiary is listed shares can be specified, that share is fixed at outset and cannot be changed.
- Survivors Discretionary Trust – a Trust designed to work with joint life first death policies where, in the event of the death of one Settlor, death benefits are held for the surviving Settlor exclusively. If both Settlor’s die within 30 days of each other the benefits go into a discretionary arrangement.
Which Trust should you use?
Not all providers use exactly the same trust names as above but most will have similar range of Trust arrangements.
Which type of trust is best for you depends on your circumstances.
Absolute Trusts give the Settlor no flexibility. For example if you have two children and name them as beneficiaries, then have a third child, he or she cannot benefit from the Trust. An absolute trust may be suitable for a spouse to spouse arrangement where there are no children involved, or for a single person gifting to charity.
Flexible Trusts allow for changes to beneficiaries so work well if additional children need to be added as beneficiaries at a later date.
Discretionary trusts put the control of the final beneficiaries into the hands of the Trustees. They may be suitable for those with no direct dependents who might wish to leave decisions on beneficiaries on their death to others.
Survivors trusts are suitable only for policies which are written on a joint life first death basis (two people covered by the plan, but proceeds paid only once).
This page is intended as a guide only. It should not be considered financial advice. If you wish to put your policy in place obtain advice from a suitably experienced and qualified person