Putting a life policy in trust is usually the right move, but "in trust" is not the same as "outside your estate". Whether the money reaches your family free of inheritance tax depends on which trust was used and who is named in it. The standard form supplied with a policy is completed by the family itself, usually without legal or tax advice, and it does not always do what they believe it does.
Why policies go into trust at all
A life policy that is not in trust normally pays into your estate. That means it waits for probate, and it can be taxed at 40% above the allowances. Written into the right trust, the proceeds are paid to the trustees instead, quickly and outside the estate.
That much is well known. What is less well known is how easily the wrong form, or the wrong name on it, undoes the point.
Where it goes wrong
Naming your spouse outright. Many standard forms are simple trusts in which the beneficiary is fixed: the money belongs to the person named. If that person is your husband, wife or civil partner, the payout becomes part of their estate. No tax is due on your death, because of the spouse exemption, but the money is then exposed on theirs. The policy did its job once, and the tax is simply postponed.
Children under 18. The same kind of trust, naming your children, gives each child an absolute right to their share at 18. That may not be what you would choose for an eighteen-year-old receiving a large sum.
Joint policies that pay on the first death. A policy covering a couple that pays when the first of you dies raises its own question: you both effectively put it into trust, and the survivor may also be a beneficiary. Getting that right for inheritance tax means each of you being excluded from benefiting from your own share, and many standard options simply pass the money to the surviving partner instead.
Large policies and the trust tax regime. Most flexible trusts created today fall into what is called the relevant property regime. For a typical term policy that rarely produces tax, but larger and longer policies, whole of life cover in particular, and proceeds that sit in the trust after a claim, can be caught by charges every ten years and when money leaves the trust. It needs planning at the outset, not discovering later.
Timing matters
The tax charge on putting something into a trust is a charge on the gift, so it falls on the person making it. A new policy put into trust at the outset is worth very little, so the gift is very little. The payout years later is the trust's own asset turning into cash, not a new gift. Put a policy in trust early, while it has little value, not once it is worth something.
Term or whole of life?
- Term assurance covers a fixed period. It suits a defined risk: a mortgage, the years your children depend on you, or the seven years after a large lifetime gift.
- Whole of life cover pays out whenever death occurs. It is the usual tool for funding an inheritance tax bill that will arrive whatever happens, often written on a couple's joint lives to pay on the second death, when the bill actually falls due.
For a fraction of the bill, a policy in the right trust can pay your family's inheritance tax for them.
Many families need one, some need both, and some need neither. The type of trust should follow from which it is.
Standard form or advice?
The standard trust form is not a bad document. It is a general one. It cannot know whether you are married, have children from an earlier relationship, own a business, or have an estate that will face inheritance tax.
Advice is what matches the trust to the family. That is the difference you pay for: not the paperwork, but the certainty that the policy you have paid premiums on for years actually reaches the people you meant it for, in the way you intended.
If your policy is already in trust, it is worth checking which trust was used and who is named. It is usually a short review, and it is far easier to fix while you are alive than for your family to discover afterwards.