Most people, would be able to explain the basics of life insurance without too much prompting as the concept is straightforward. But how many people understand the idea of putting insurance into trust? A recent article in the Saturday Telegraph illustrated one potential pitfall of not really understanding what is going on. (The original article is at http://www.telegraph.co.uk/finance/personalfinance/insurance/lifeassurance/11396121/The-life-insurance-pitfall-that-cost-40000.html).
Just so we are on the same page, life insurance is a legally binding contract usually written between the policyholder and an insurance company. Where, upon the policyholder’s death during the term of the contract, an agreed sum of money is paid to the now-deceased policyholder’s estate. Under normal circumstances, the proceeds will be subject to inheritance taxation and distributed according to the will of the deceased or the laws of intestacy.
Putting a policy into trust changes the picture. The proceeds now belong to the trust and will be distributed according to the terms of the trust. This will usually bypass the will, and normally remove it from inheritance taxes. If there is no will, the trust will still be effective for the policy proceeds.
Putting a simple life policy into trust is almost always a good idea; polices written in trust can be distributed without waiting for probate and will not have any bearing on any death tax calculations. Where someone has not made a will, or where a previous will is now invalid, the trust will pay out to the nominated beneficiaries without delay or reference to anyone else.
Policies written into trust usually come undone due to a basic lack of flexibility and a lack of understanding by clients, advisers and providers. Most trusts used for life plans are ‘absolute’ trusts, so are not usually capable of changes beyond cancellation and replacement; this was the issue highlighted in The Telegraph article. As absolute trusts have tax advantages over discretionary trusts, there is no expectation of any changes in the law, so it would be wise to be cautious when setting up a policy in a trust, to ensure that it will be effective when the time comes.
So, when is a trust for a life policy worth considering?
1. When you want to keep the policy proceeds out of the estate for tax purposes.
2. When there is a need for a rapid settlement on death.
3. When a policyholder is wanting to make a specific provision for a named individual in advance of writing a will, bypass an existing will or to conceal the ultimate beneficiary.
4. Whenever the proceeds are earmarked for a specific outcome.
Anyone who has significant personal assets, has not written a will yet or expects the existing will to be invalid, the divorced and remarried, those with step-children, children from a first marriage or just a complicated love life may benefit from putting life cover in trust.
Remember from murder mystery fiction, putting all of your assets in one basket on death, (a tontine), gives the most unstable member of your family a good reason to see you off and bump off your remaining relatives, (http://en.wikipedia.org/wiki/Tontine).
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The information contained is for guidance only and does not constitute financial advice. It is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change. Accordingly no responsibility can be assumed by Martin-Redman Partners its officers or employees, for any loss in connection with the content hereof and any such action or inaction.