Putting Life Insurance in Trust - What Does it Mean?
Taking out life insurance to ensure your loved ones get financial security in the event of your death is an important part of your monetary planning, but sometimes simply putting it in place and letting it be dealt with by your beneficiaries when the time comes can result in problems or mismanagement.
There’s the option to put your life insurance into trust to make sure it is dealt with in the way you desire, and doing so is likely to make payment more efficient too.
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Despite being a term that seems confusing and the province of rich schoolboys, a trust fund is actually very simple – and the clue is in the name.
When you write your life insurance into trust you are simply saying “I trust this person (named) to use this money for the purpose I intend.”
You then set up a trustee (or multiple trustees) – the person or people you trust to deal with the money and declare the intended use of the money. They agree to comply with your wishes and use the money in the right way once it becomes in their control.
So, why have a life insurance trust? Well, there are certainly more life insurance trust advantages than disadvantages:
Ease of administration
Due to the nature of inheritance laws, sorting out your estate (everything you own that you leave behind) can be complicated and often long-winded, especially if there isn’t a will.
Setting up a trust for life insurance essentially bypasses these problems and gets the money directly to where you intended without delay.
If you die without a will, your estate is passed on according to the laws of intestacy. This could be as simple as it all going to your next of kin, or it could involve legal issues and confusion.
The process of administering an estate that is intestate can take months and disputes are common. Any money you intend for a specific heir or for a dedicated purpose could take so long to reach them that they are already suffering financial hardship.
Or, it could even end up in a place or with a person you didn’t want entirely.
Even with a will in place, your estate must go through probate, which is essentially the process of “proving” and validating its authenticity.
There are fewer disputes with a clear will, but there might still be problems and legal issues.
Life insurance trusts bypass the process of intestate administration and probate, and are paid immediately to the trustees by the life insurance company upon presentation of the death certificate.
Avoidance of inheritance tax
Life insurance trusts are not considered part of the estate and do not contribute to the total estate value for inheritance tax valuation.
Setting up a trust to avoid inheritance tax is a perfectly legal and sensible option.
Inheritance tax is paid on all value of the estate above the nil rate band (currently £325,000), so with a house valued at £300,000 and a life insurance policy of £300,000, the estate would immediately be subject to taxation.
With the life insurance money put into trusts to avoid inheritance tax, only the remainder of the estate would factor into the calculation and the total amount of IHT would be lowered or even removed altogether.
It is also possible (and indeed, sensible) to set up a life insurance policy for the express purpose of paying inheritance tax.
Pre-evaluating the estate will allow you to estimate the expected amount of inheritance tax and take out a life insurance policy in trust to cover this duty.
In the event of your death, the policy would immediately pay out to the trustee who can then pay the inheritance tax on the full estate without difficulty or delay.
Money going as intended
If you wish to get money directly to a minor for when they mature, or to be used for a specific purpose, then writing the life insurance in trust is a guarantee that your wishes will be followed.
It is one of the life insurance trustees’ responsibilities under law that they must use the money as you have directed.
Putting money into trust means you can set very specific criteria as to its use. The example of providing money that a child inherits only once they reach adulthood is a simple one that shows the effectiveness of a trust inheritance.
Without the trust, you would have to rely on their sense at a young age to not waste the money you have carefully planned for.
It is sometimes the case that policies worth hundreds of thousands of pounds suddenly find themselves in the hands of a minor with no financial experience or understanding and these sums can be abused by unscrupulous parents or other influential adults, as well as being wasted by the child themselves.
The trustees you choose do not have to be related to the child you want the money to go to – many people choose a neutral body such as their solicitors to administer the responsibilities of the trust fund.
There are many different types of trust, but the most common for life insurance is the discretionary trust.
This type of trust means you specify your intended desire for the money and put your faith in the trustees to use the money wisely with that intent. It gives the trustees discretionary powers to use the money as and when they deem it necessary and can help avoid future problems.
For example, a discretionary trust under the control of a surviving parent for a child means that parent can make decisions regarding the money for circumstances that weren’t dictated in the trust details, provided they are in the child’s best interest.
Maybe the opportunity for an educational trip comes up that the trust fund can pay for but was never envisioned, or an unforeseen accident means the child needs a new bed. Larger and more serious unexpected needs, such as medical treatment, can also be paid for by the trust fund via the trustee.
A non-discretionary trust would mean that despite the child having an immediate need for the money, it is otherwise tied up and cannot be accessed.
A discretionary trust does mean that you must genuinely value the prospective trustees’ opinions and judgement. To mitigate problems, you can specify multiple trustees and the funds can only be accessed with a consensus.
It could be possible that the trustees of a discretionary trust misuse the funds for their own benefit. This would break the rules of the trust and the end beneficiary, having been cheated out of their rightful money, would have solid grounds to take the trustees to court for compensation once they reached adulthood.
It is fairly simple to set up your life insurance to be paid into trust. A basic life insurance trust form is free and can be requested at the time of policy application.
However, if you have specific or complex needs, you may want to involve legal representation to help with the details and even act as a trustee. In these cases, you should speak to your solicitor and find out the appropriate fees and process.
It is also possible to transfer an existing life insurance policy to trust – contact us if you would like to adapt your current life insurance in this way and we’ll be happy to help.
Should I put life insurance in trust?
For many people, putting life insurance into trust is the right thing to do for one or more of the reasons discussed above.
Many simply trust their spouse or other next of kin to administer their estate appropriately and see no need to tie their hands through trust funds.
Only you can really know your circumstances and the relative trustworthiness (or reliability) of your beneficiaries.
It may be that you want to put joint life insurance in trust, which would be a decision both policy holders must make together.
In all cases, it is important to remember that you cannot predict the circumstances surrounding your death.
While you might trust your spouse as sole benefactor, knowing that he or she would do the right thing for your family, it could be that the two of you sadly die together in an accident and the estate would end up in the hands of a someone you hadn’t properly briefed or whose opinions on the right way to administer your family’s finances are not in line with yours.
Although they cross over in concept, a will and a trust fund are very separate things.
While putting your life insurance in trust effectively bypasses the will, it does nothing to protect the other parts of your estate, including the family home and your valued possessions.
A life insurance policy written into trust is a single part of your estate – you will still need a will to direct what happens for all the other parts.
If you are considering writing your life insurance policy into trust, it is worth seeking independent legal advice first. While it is possible to write a trust without any outside advice (just as it is with a will), legal language is such that loopholes can (and will) be exploited by anyone seeking to work around your wishes.
This is especially true when the object in question is a sizeable life insurance policy worth many hundreds of thousands of pounds.
Make sure that you discuss your thoughts with the people you would like to be trustees. You cannot simply appoint a trustee without their agreement, so you will need to talk candidly with them and make sure that their attitude is in line with yours.
Don’t feel forced into choosing someone as a trustee just because they would be offended to be rejected – if this is the case, then that is an example of showing a quality that only proves they would make a poor trustee!
If your family situation is emotionally complicated, then choosing a solicitor as a trustee provides a neutral and problem-free solution.
For more advice regarding life insurance trusts, to move your current policy into a trust fund, or just to find our more about life insurance options, contact Unite Life today.