How Does a Life Insurance Trust Work?

If you put a life insurance policy into a trust, it will be managed by a trustee that you choose. You, as the settlor (who puts assets into a trust), hand over ownership of the policy to that trustee, who will make the claim if you die while you’re covered by the policy, and manage the trust in the meantime. You must keep paying the premiums for your policy, but you’ve handed ownership of it to your trustees.

You can have more than one trustee. It’s recommended that you have at least two, but no more than four trustees. This can help future-proof it if a trustee can’t do the job at any time or passes away. You might choose a trusted family member or friend, or you may use a solicitor firm for the role, for a fee.

The trustees are legally responsible for managing the trust and making sure your beneficiaries receive the payout as you’ve directed, as set out in the terms of the trust, called the trust deed.

What types of life insurance trust are there?

There are two main types of trust:

A bare trust, sometimes called an absolute trust or fixed-interest trust, is one of the simplest types. You can hold the lump sum until your beneficiaries reach 18 (16 in Scotland). This means they won’t receive any lump sum payout until they are old enough, if you die before they reach that age.
A discretionary trust can let trustees decide which beneficiaries to pass the lump sum to, along with how much and when. You can make a letter of wishes with your will to explain how you would like it to be distributed, but it’s down to the trustee’s discretion. A letter of wishes is only guidance and doesn’t have to be followed by law. The trustee must always act in the best interests of the beneficiaries.

Besides these, there are a few other types of trusts for life insurance policies, so it can get quite complicated. If you have specific or complex directions you would like to give, you will need to use a solicitor and get their guidance.

How to put life insurance in trust

If you are taking out a new policy, your insurer will usually offer you the chance to put the policy in a trust. You will need to fill in a form and name your beneficiaries and trustees, and it should be a straightforward process. This should be free of charge, but if you choose to use an independent solicitor, you’ll pay a fee for their services.

If you already have a life insurance policy that you want to put in a trust, check if this is possible with your insurer. You may need to use a solicitor or take financial advice before going ahead, though, especially if you want to make any changes.

» MORE: Can you have more than one life insurance policy?

How long does a life trust last?

Trusts can last as long as 125 years, so your life trust can last as long as you need it to. If you’re leaving the payout to a charity, there is no end date. You will be able to state how long you need it for when you set up the conditions in the trust deed.

You may want to set it up for as long as your term life insurance policy lasts, or until your children are above a certain age or get married. If you’re unsure, ask your solicitor or financial adviser.

Can I make changes to a life insurance trust?

You might want to think twice before putting your life insurance in a trust if you’ll need to make changes to the policy, or to the trust, later on. You can’t undo or cancel a trust once you’ve made it, as you have passed ownership and control to the trustees. This is known as an irrevocable act, which means it can’t be reversed.

Some changes, such as when a trustee dies and needs to be replaced, or if you split up with your partner and need to change beneficiaries, may be possible, depending on the type of trust. You would need to contact the trustees and get their agreement.

Should I put my life insurance policy in trust?

If you want to control how and when the payout would go to your beneficiaries, or if you’re concerned about your estate going over the inheritance tax threshold, a trust might tick a few boxes for you.

But if your estate is unlikely to tip over the inheritance tax threshold when you die, and you don’t need to make arrangements for how and when your beneficiaries receive the lump sum, you may not consider it worthwhile. The same applies if you think you will need to make changes to your policy or the trust down the line, because it can be difficult to make changes to a trust, and you can’t cancel it once it’s been set up.

It’s sensible to take independent legal advice, even if your insurer offers to set it up for free. Trusts are a complicated legal arrangement that can have tax implications, so you’ll want to get it right. If you use a solicitor to set up the trust, perhaps because the arrangement you need is more complex, factor in how much that will cost in fees, which start at around £1,000.

What do I need to know about life insurance trust beneficiaries?

The beneficiary of your life insurance policy is the person, people or organisation you name to receive a life insurance lump sum payout when you die. So that might be friends and family, or even potential future family, or a charity.

To recap, the two other roles or parties in a trust are:

The settlor (or trustor in Scotland) sets up the trust and puts their life insurance policy in it. If it’s your policy, this would be you.
The trustees manage and control the trust for whoever the settlor wants to pass the assets to. They must be over 18, and should be someone you know and can rely on to carry out these duties.

The trustees own and manage the trust and must keep all the documentation safe, or with a solicitor. They will make the claim on your policy when you die.

Make sure that all parties are clear about how the trust works and their responsibilities. A solicitor can help you check the wording.

Life insurance trust disadvantages

It’s best to be aware of some of the restrictions when you put your policy into a trust.

You can’t undo it

Once a trust is set up, it can’t be cancelled or reversed. Some trusts, such as bare trusts, won’t allow you to change beneficiaries later on.

You’re passing ownership to the trustees

The trustees will own the policy as soon as it’s set up. You continue to pay the premiums, but you have passed ownership to them. You can leave instructions for some trusts, but the trustees make the final decisions.

Life insurance trust advantages

There are some common reasons why people use trusts for their life insurance policies.

To leave specific directions about how beneficiaries receive the money

You may want children to wait until they reach the age of 18 before they inherit, have future grandchildren you want to make provision for, or a vulnerable family member you want to help protect. This can give you more control to potentially hold or distribute any life insurance payout the way you would like, to help benefit them.

Beneficiaries receive the payout faster

As the trust is generally considered separate from your estate, your beneficiaries will receive the lump sum without having to wait for a grant of probate. Instead, they may get their inheritance just a few weeks after the death certificate is issued. The probate process can take months.

To protect the lump sum from inheritance tax

If you put your policy in a trust, the payout won’t be counted as part of your estate, so it won’t usually be liable for inheritance tax (IHT).

Life insurance payouts are usually tax-free, so the lump sum isn’t liable for income tax or capital gains tax. But the money would be liable for inheritance tax if your policy isn’t in a trust and your estate is valued at more than the inheritance tax threshold, currently £325,000. Anything over that (including the life insurance payout) would be taxed at 40%.

Bear in mind that there are some points where IHT might be charged even when your policy is in a trust, such as a charge on the value of property every 10 years or when it’s first set up. A financial adviser or estate planning solicitor can help explain the tax implications.

» MORE: Inheritance tax: who pays it and when

If you’re an unmarried couple with no will

If you name your partner as a beneficiary of your life insurance trust, you can rest assured you have made provision for them. Otherwise, if you are not married or in a civil partnership and haven’t made a valid will, under the rules of intestacy your partner wouldn’t receive anything, even if you lived together.

If you have a joint life insurance policy with a first-death policy, the payout would go to the surviving partner. But if you want an additional beneficiary in case both partners pass away at the same time, or have a second-death policy, writing the policy in trust might be a useful way to help reduce any potential inheritance tax bill.

Some trusts are flexible

Discretionary trusts, for example, can allow trustees to make decisions over time to bear in mind the changing needs of beneficiaries. This might be if grandchildren are born, or your children’s income changes and you want trustees to take account of that.

If you would like to get legal advice to make sure trusts are right for you, you can find a solicitor through the Law Society of England and Wales, the Law Society of Scotland or the Law Society of Northern Ireland.

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