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What is a Trust?

One of the reasons a Trust can be set up to is specify who will receive your life insurance proceeds in the event of death.

If your life insurance policy is ‘Written In Trust’ then, in the event of the claim, the insurance company pays the sum assured via the Trustees to the beneficiaries you name on the policy.

This means that the proceeds from the policy never form part of your legal estate and are not subject to Inheritance Tax.

A Trust is created by Settlor, also known as a donor or a grantee, who entrusts their insurance policy to people of their choice, the Trustees.

Trusts can be used for the following benefits;

 

  • They can ensure payments are made without any probate delay,
  • They can help lessen the effects of Inheritance Tax, as the proceeds fall outside of the deceased’s taxable estate when the plan holder dies,
  • They can make sure the proceeds will be paid to the Beneficiarieschosen by the settlor.

 

The problems that can arise if a policy is not ‘Written In Trust’ might include:

 

  • Without a valid Will, the proceeds will have to be distributed according to the laws of intestacy
  • The Legal Personal Representatives of the estates wont be able to obtain the proceeds of the plan until probate has been granted
  • The beneficiaries may have to pay 40% tax on the life insurance proceeds.

 

To better understand the tax implications, let’s take a look at the following example.

 

Take Mr Smith. He’s a widower and wants to leave everything equally to his two sons. He owns his home which is currently worth £345,000 with a £90,000 outstanding mortgage. His investments are valued at £52,000 and his car and other possessions are worth £18,000. He also owns a life insurance policy for £250,000 which is not written in trust. We assume that the costs of administering his estate and obtaining probate would be £5,000.

If Mr Jones were to die now, his estate would be worth £570,000. Inheritance Tax is currently levied at 40% on the value of his estate over and above £325,000 therefore his sons would each receive £236,000 but the taxman will walk off with £98,000 just because the life policy was not written in trust.*

Now let’s assume exactly the same figures except that in this case the life insurance policy is Written in Trust with Mr Smith’s sons as equal beneficiaries.

 

Because the life insurance company pays out directly to his sons, they each receive £125,000 straight away. None of the money is included in Mr Smith’s estate.

 

This means that his estate is now worth £320,000 and the taxman walks away with £0. Each of his sons receives the initial £125,000 and the full value of the estate, another £160,000 each, all tax-free!*

So simply by placing his life insurance plan in trust, Mr Smith saves £98,000 in tax!

* HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.

  • This information is provided as a guide and is not offered as advice. Individuals should seek independent advice form a qualified tax specialist to understand their personal tax liabilities.

 

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