Life insurance is something most people take out to protect the people they love. But there’s a common and costly mistake that even careful planners make: leaving a life insurance policy outside of a trust.
When a life insurance policy is not written in trust, the payout forms part of your estate when you die. That means it could be subject to Inheritance Tax, a 40% charge on everything above your available allowances. For a policy worth several hundred thousand pounds, the tax bill can be significant.
Writing your life insurance in trust is a straightforward but often overlooked step that can mean the difference between your family receiving the full benefit of your policy and HMRC taking a sizeable chunk.
At Beaumont Wealth, this is one of the first things we look at when reviewing a client’s estate plan.
What does “written in trust” mean?
When a life insurance policy is “written in trust”, the policy is legally held by a trust rather than owned outright by you. The trust names beneficiaries, usually your spouse, children, or other family members, who receive the payout directly when you die.
Because the trust owns the policy rather than you personally, the payout falls outside your estate for Inheritance Tax purposes. It goes directly to the people you have named, without waiting for probate and without being included in the estate valuation.
Two key benefits of writing life insurance in trust
Writing life insurance in trust addresses two significant practical issues.
It removes the payout from your estate. If the policy is in your estate, and the estate is already above the IHT threshold, 40% of the policy value disappears before your family sees it. A £500,000 policy could be reduced to £300,000 by the time IHT and other costs are settled. Outside of a trust, that £500,000 goes to your beneficiaries in full.
It speeds up the payment process. Probate, the legal process of administering a deceased person’s estate, can take months, sometimes over a year for complex estates. Life insurance policies that sit within an estate must wait until probate is completed before they can be paid out. A policy written in trust can be paid out quickly because it sits outside the probate process entirely. For families facing immediate costs after a bereavement, this matters enormously.
Which types of life insurance work best in a trust?
The most common policies written in trust for IHT planning purposes are:
Whole of life insurance – this type of policy pays out whenever you die, rather than expiring after a set term. Because the payment is guaranteed (rather than dependent on dying within a specific window), it is particularly effective as an IHT planning tool. The payout can be used by beneficiaries to settle an IHT bill, meaning the rest of the estate remains intact.
Term life insurance – a standard term policy can also be written in trust, and this is usually a simple and free process that most insurers offer. Even if you have a term policy for family protection rather than IHT purposes specifically, writing it in trust prevents the payout from being taxed as part of your estate.
How does a whole of life policy work as an IHT tool?
The idea is straightforward. If you know your estate is likely to face an IHT bill, a whole of life policy written in trust can be structured to match that liability. When you die, the trust pays out directly to your beneficiaries, who can then use the funds to settle the tax bill without needing to sell property or other assets.
This is sometimes called “covering the IHT liability”; essentially, your premiums are paying for a policy that funds the tax bill, leaving the rest of your estate undisturbed.
For married couples, this is often structured as a “second death” or “last survivor” policy, which pays out when the second partner dies (since no IHT is owed on the first death due to the spousal exemption).
Are there any downsides?
Writing a policy in trust is not entirely without consideration:
You give up control. Once a policy is in trust, you can no longer cash it in or change the beneficiaries without the agreement of the trustees. This is why choosing the right type of trust and the right trustees matters.
It is not reversible. Once done, it can be difficult to undo. This is why it is worth getting proper advice before setting up a trust rather than after.
The trust structure needs to be right. There are different types of trusts: discretionary, bare, and flexible, and the right choice depends on your family situation, your intended beneficiaries, and your goals. A poorly structured trust can cause complications, particularly if circumstances change.
How does this fit into a broader IHT plan?
Life insurance in trust is one tool among several. It works best as part of a coordinated IHT strategy that may involve several other planning measures.
Making full use of the nil-rate band and residence nil-rate band, covered in our guide to how much you can inherit without paying tax
Business Relief for business owners: see our article on Business Relief and IHT for business owners
Lifetime gifting and use of the annual gift allowance
Pension planning, since pensions typically sit outside the estate, we explore this further in our pension advice pages
How Beaumont Wealth can help
Our advisers work with clients across Shrewsbury, Chester, and the wider region to ensure their life insurance arrangements are structured correctly and serve their estate planning goals. If you have an existing policy that is not in trust, or if you are thinking about taking out life insurance for IHT purposes, we can help you understand your options and put the right structure in place.
Talk to the Beaumont Wealth team about your estate planning today.
