Why Put Your Policy in Trust
If you are planning on taking out life insurance to provide your loved ones with financial security in the event of your death, you may want to consider writing it in trust to protect it from the taxman.
Although you don't have to pay income tax on payments from life insurance policies, your dependents could still be hit with a nasty inheritance tax bill which could be avoided with a bit of forward planning.
How inheritance tax works
If, when you die, the value of your estate is valued above £325,000 (if you are single or divorced) or £650,000 (if you are married or widowed), everything you own above this threshold will be liable to inheritance tax at 40%. Your estate includes all your assets such as your home, savings, possessions and any life insurance payment - unless it is written in trust.
So if, for example, your estate is valued at £525,000 your inheritance tax bill will be £80,000, which is 40% of the £200,000 above the £325,000 threshold. However, you do not have to pay inheritance tax on life insurance policies which have been written in trust.
What is a trust?
A trust is a legal arrangement designed to help you ensure that the proceeds from your life insurance policy are used exactly as you intend. If you do not have a trust, then the money could be used to pay off outstanding debts, rather than going to your dependent’s as you instructed.
Trusts enable you to confirm who should receive the proceeds of the policy and they remove the need for probate - the legal limbo into which a deceased person's affairs can disappear if they don't leave a will. If your life insurance is 'written in trust', your loved ones can get access to the money more quickly - usually just a few weeks after the death certificate is produced.
If the policy is not written in trust, your executors will have to apply for a grant of probate and the policy may not pay out for several months.
Writing the policy in trust means any payment on death is outside of your estate for inheritance tax purposes. In fact, many people take out a life insurance policy written in trust specifically to cover the cost of their inheritance tax liability.
When you set up a trust, you are then known as 'the settlor'. You then choose the 'trustees', who are responsible for looking after the policy. It is up to them to make sure your beneficiaries receive the money as and when you want them to.
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