Life Insurance – Make Sure It is Written into Trust

Inheritance tax is a contentious issue in the UK.  If your net assets are valued at more than £325,000 when you die, any money you leave to anyone other than your husband, wife or civil partner, is taxed at 40%.  This also applies to money from a life insurance policy, even if you have made a Will. If you have a life insurance policy and when you die your estate claims on it, the money then goes to your estate.

So in effect, 40% of the benefits you receive from the insurance policy will go to the Government.

Reducing Your Inheritance Tax Liability
But there is a way to avoid this.  If you write the policy into Trust while you are alive (in effect, giving the policy away while you are alive), the money does not go to your estate – so as you do not own the benefits of the policy you cannot be taxed on it. Inheritance tax is then only payable on the net value of the estate (not including the proceeds of the life insurance policy). A life insurance Trust does not pay tax on the payout from a life insurance policy.

The answer then lies in having your life insurance policies written into Trust.  If your policy is already written into Trust you will know as you will have appointed Trustees.  It goes without saying that a Trustee should be someone you trust!  This could be a friend, husband, wife or other family member.  If you appoint a professional Trustee they will probably charge for their services so make sure any fees are clear to you.

A Common Mistake
Imagine this scenario – you are married and have a small property portfolio, with equity in this and your own home of £325,000.  You also have life insurance of £500,000.  On your death your wife will pay no Inheritance Tax as she was married to you.  Your wife is now worth £825,000.  When she dies and leaves everything to your children, they receive the first £325,000 free of tax.  But the remaining £500,000 (proceeds of the life insurance policy) is taxed at 40% – a sizeable £200,000.

Solving the Problem
If the life insurance had been written into Trust, neither you nor your wife would have owned the proceeds. The policy would have been managed by the Trustees and both you and your wife, together with your children, would have been the beneficiaries. The Trustees are obliged to use the money for the benefit of the beneficiaries (it is called a Fiduciary Duty) and the family could have drawn money from the Trust when they needed it, rather than it being a part of the estate and so increasing Inheritance Tax liability.

It is shocking to think that lack of foresight could lead to losing £200,000 in this example but it does highlight the importance of planning ahead.  Of course, it is essential to consult a tax planning specialist so that you receive accurate advice – but this costs less than many people think.  If you would like further advice or are looking for a specialist, we can offer suggestions. For Tax Guidelines relating to property, download our free guide here.