Life insurance can be a very important financial product for people who have relatives depending on their income. But issues can arise if and when a life policy pays out, as the money can be subject to inheritance tax.
At present, inheritance tax is charged at 40% on any part of a deceased person’s estate above £325,000.
Rising property prices in the UK mean that more and more people are finding themselves caught in the IHT net.
Sizeable life insurance payments can easily push estates above this level if they are not there already, resulting in tax bills running into thousands of pounds.
However, there is a way to potentially avoid inheritance tax on a life insurance payment, and that is by holding your policy in Trust.
Could your life insurance be used to pay the inheritance tax due on your estate?
What is a Trust?
A Trust is a legal arrangement that allows someone to earmark property or assets – in this case a life insurance policy – for a specific person or people, known as the beneficiaries.
Trusts are run by trustees who are legally responsible for the contents of the Trust, but who are bound to pass the assets on to the named beneficiaries at the appropriate time.
Does the type of life insurance cover you need change as you get older?
How can Trusts help?
One of the primary reasons for setting up a life insurance policy in Trust is to avoid inheritance tax. Assets in Trusts will not normally be considered part of a deceased person’s estate for tax purposes. Outside of a Trust, any pay out could be subject to a deduction of up to 40% by the taxman.
There is a further advantage: because the life insurance money is not part of the policyholder’s estate, it does not need to go through the probate process – which can in some cases take weeks and even months – before relatives are paid. This means they should get the pay out much more quickly, which can be very important if it is needed to meet day-to-day expenses.
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Potential drawbacks of Trusts
The decision to use a Trust is not always straightforward, however. There are likely to be extra costs involved in setting one up, and it will be harder, or at least more time-consuming, to cancel a policy once it is inside a Trust as the agreement of the trustees is required. However, if you simply stop paying the premiums, the policy will probably lapse and be cancelled by the provider.
Trusts are a complex aspect of the law, and there are different types available. Discretionary Trusts, where the person who set it up has the power to change the beneficiaries, are one of the most common kinds.
In any case, it is a good idea to seek expert legal advice if you are considering this course of action.