Losing a partner or parent is one of the most harrowing experiences in life but fighting for a life assurance payout at the time it’s most needed can make it much worse.
Yet this is the reality facing many who are grieving for a loved one.
It can be easily avoided if you know how, a life insurance policy written in trust should not only pay swiftly but also avoid ending up as part of your estate and liable for inheritance tax.
Sometimes a life cover payout will be rolled into your estate, bumping up its value and potentially even taking you over the inheritance tax threshold
If you buy a life assurance policy online or from an insurance company directly you pay in every month and the assumption is, when you die, it pays out to your partner or children so they don’t have to worry about funeral expenses, paying the mortgage or the monthly bills.
However, it rarely works like that: insurance companies can take months to process a claim and pay the cash out to your family, leaving them high and dry at an already difficult time.
Worse, sometimes a life cover payout will be rolled into your estate which includes the value of your home, potentially taking you over the inheritance tax threshold of £325,000.
That can leave your loved ones with a bill equal to 40 per cent of anything over that amount.
But there is a simple way to avoid this: putting a life policy into trust allows the policy holder to appoint anyone they wish as a beneficiary of the trust, meaning your family is paid the full lump sum on death without the worry of a huge inheritance tax bill.
Phil Jeynes, from protection comparison site UnderwriteMe, explained: ‘A trust is simply a document which tells people what you want done with your money once you’re gone.
‘It cuts out all of the legal delays which often occur when distributing someone’s estate and means insurers know who to pay and how much.’
Financial advisers should be able to set up life cover in this structure easily but many don’t unless you ask them specifically.
Inheritance tax is paid if a person’s estate (their property, money and possessions) is worth more than £325,000 when they die.
This is called the inheritance tax threshold.
Married couples and civil partners can pass their unused allowance to the survivor, which effectively doubles the threshold to £650,000.
The Chancellor has also revealed plans for a new nil-rate main residence band that will start at £100,000 in 2017 and step up to £175,000 by 2020 for those leaving their home to a direct descendant.
There are different thresholds for previous years which you can view here.
The rate of inheritance tax is 40 per cent on anything above the threshold.
The rate may be reduced to 36 per cent if 10 per cent or more of the estate is left to charity.
Currently, just one in in ten life policies is written in trust.
Mark Locke, protection specialist at financial services consultancy The Lang Cat, said this could be because most advisers charge a fee for financial planning when putting a policy into trust. There may also be legal advice to pay for.
He said: ‘When most people buy life insurance they’re looking for the cheapest deal which is why they don’t always think about what the consequences of not putting it into trust are.
‘If you are taking life insurance out though, the reason is that you care about your family being financially secure if you are no longer around – for that reason alone it is worth having a conversation with your adviser about how best to achieve that goal.’
If your life cover cash is meant to go to your wife and kids, a trust makes sure it does without unnecessary delays.
Jeynes said:’You can put any protection cover in trust but life insurance is the most obvious fit. It’s very easy and involves minimal paperwork. Speak to your adviser or just get in touch with the insurer directly. You don’t need to alter the policy itself or take any new cover.’
Legacy: Trusts can be used to pay school fees for children or grandchildren
Putting life cover into trust also allows lump sums to be paid out to others more easily. For example grandchildren can be beneficiaries to remove potential future inheritance tax payments and to meet specific needs such as school fees.
It also ensures a definite outcome without a will being involved.
Alan Lakey, an adviser at Highclere Financial, said: ‘If you don’t put life cover into trust, most insurers will wait until probate has been given or letters of administration for those who die intestate – without a will.
‘The value of the insurance payout is then added to the value of the estate and could suffer 40 per cent inheritance tax while if no will has been written then the money could go to somebody that the insured never intended.’
If you have an existing life policy which isn’t in trust, it’s a fairly straightforward process to transfer it.
Lakey said: ‘This can be achieved fairly easily but care needs to be taken if the life assured is in ill health.
‘This could be deemed by the taxman as a disposal beyond the annual inheritance tax exemption and the benefits would be subject to tax.’
Johnny Timpson from Scottish Widows said: ‘Professional advice should always be sought as to the type of trust that you require to achieve your objectives.
‘Life companies normally have a number of draft wordings available off the peg that could well be suitable for personal or business purposes but in other instances, legal advice should be sought.
‘Each trust works slightly differently and it’s important to choose the one that’s right for you, hence the need for advice.’
DIFFERENT TYPES OF TRUST
Plain and simple trust that does exactly what you want
Trusts can take the pain out of managing a person’s estate after they’ve gone
This is the simplest form of trust; in fact it’s sometimes called a bare, plain or absolute trust.
Once you have written a bare trust it cannot be changed.
The settlor (the person setting up the trust and putting property, wealth or insurance policies into it) decides who the beneficiaries are and what they want each of them to receive.
From then on the property in the trust and any profits from it belong to the beneficiaries listed in the trust.
As the beneficiaries and their benefits are taxed in a bare trust, it is not possible to add beneficiaries in the future even if the settlor were to have more children or grandchildren.
Once a life cover plan is in a bare trust, the settlor can’t benefit from it. So a bare trust isn’t suitable for a policy that includes any cover that would pay a benefit to the settlor if a claim were made while they were alive. For example, a plan that includes critical illness cover isn’t suitable for a bare trust.
With a bare trust the trustees can’t make any beneficiary over the age of 18 wait before they receive property that the trust is holding for them. This can be a concern if the beneficiaries are young and the trustees think they should wait before they receive the trust property.
Straight forward trust where you want your appointed trustees to have the ability to make discretionary decisions on your behalf
A discretionary trust relies on the discretion of the trustees who are appointed by the settlor to manage the trust. In a bare trust the assets must be distributed to beneficiaries who are over 18 if they ask for them but with a discretionary trust the trustees can retain assets until they think it is the right time for them to be distributed.
The trustees can choose who will benefit and how much they will receive which means that they may ‘pass over’ some of those listed as ‘potential beneficiaries’.
It is very important therefore that you help the trustees by indicating who you would like to benefit from your plan either by naming them in the potential beneficiaries section of the trust or by completing an expression of wishes form which can be kept with the trust form.
The expression of wishes form is not a legally binding document but it will help to guide the trustees when the time comes for them to distribute the policy benefits to the beneficiaries.
Unlike a bare trust, new beneficiaries can be added to the trust or removed from it. This can be useful if, for example, the settlor has another child or grandchild or if they fall out with someone they previously wanted to benefit from the trust.
One of the risks of a discretionary trust is that the trustees have considerable influence over the trust, its assets and its distribution. So choosing the wrong trustees can lead to complications in the future. For example, they could refuse to allow the settlor to add another beneficiary or appoint another trustee. They could also refuse to give some of the trust fund assets to a beneficiary, even though you would have wanted them to receive it.
The discretionary trust also includes a power for the trustees to make loans to individuals who may be beneficiaries of the trust.
Split trust if you want to access the policy proceeds should you be diagnosed as being terminally ill or as having a critical illness
A split trust allows you, as settlor, to split your policy so that you can retain some of the benefits and some are put into trust. With a split trust the benefits of the life cover would have to be paid into the trust but the settlor could choose to retain other benefits, including the terminal illness element of their life cover.
Other retained benefits are likely to be things like critical illness cover, the sort of covers that are designed to help protect the settlor’s lifestyle and/or replace income, help pay for care, alterations that you may need to make to your house etc.
Beneficiaries can be added and trustees appointed or removed but only with the approval of the trustees. As with a discretionary trust, one of the risks of a split trust is the power that the trustees have. Again, this is one of the reasons why it is important to choose the right trustees.