Guide
Life insurance and trusts explained
What is a trust?
A trust is a legal arrangement that allows you to leave your assets to the people you choose. These people are called beneficiaries. Assets can be money, property, investments and personal possessions. A life insurance policy is also an asset and can be put into a trust.
As the person setting up the trust, you’re known as the settlor. The person looking after the trust is called the trustee.
The trustee can be a family member, friend or a professional, like a solicitor. They have a duty to manage the trust in line with the trust rules that you both agree to. But ultimately, the trustee looks after the trust in the best interest of the beneficiaries.
Learn more about life insurance beneficiaries.
How do trusts work?
When you put your assets in a trust you effectively gift them to the trustee. This means the trustee owns the assets in the trust. They control what happens to the assets, but usually follow the instructions you’ve set out in the trust rules.
Because the assets in the trust are now owned by the trustee, they no longer form part of your estate. This means they are not included in the inheritance tax calculations on your death. So, a trust is a useful tool for managing your inheritance tax liability. It also means that anything held in the trust doesn’t need to go through probate. Therefore, the money is available to your beneficiaries straightaway.
There are several different types of trust. It’s worth getting legal advice to make sure you’re setting up a trust that works in the way you want it to. Once you’ve set up a trust, it can be difficult to make changes to it.
Who can be a trustee?
Trustees can be friends, family, a bank or a solicitor. And you can have more than one trustee managing your trust. They need to be 18 or over and someone you trust to manage your money properly. As legal owners of the trust, it’s the trustee’s job to administer the trust in the best interest of the beneficiaries.
The trustee must understand how the trust works and the consequences of any action or inaction. They must also consider the tax implications of their decisions for you, the trust and the beneficiaries.
Being a trustee is a legal responsibility and must be taken seriously. If the trustee makes decisions that are not in the best interest of the beneficiaries, they can be held liable.
The different types of trusts
There are several types of trust, and they all work in slightly different ways. Here we outline the main ones and what they do.
Discretionary Trust
A discretionary trust allows your beneficiaries to access your money during your lifetime or after your death. You don't need to name your beneficiaries individually. So, for example, you can say all your current and future grandchildren can be beneficiaries.
The trustees have the power to decide how much the beneficiaries receive and when they’ll get it. You can guide these decisions through a ‘letter of wishes’, but the trustees have the final say.
They can decide:
- whether income, capital or both gets paid out
- which beneficiaries receive payments
- when the payments are made.
This type of trust is often used to make sure that someone who can’t manage their own finances, such as a child, has money set aside for the future.
Survivor’s Discretionary Trust
This trust is useful for non-married partners who have a joint life insurance policy. It ensures that the life insurance policy will be paid to the surviving partner.
Only if the partners die within 30 days of each other will the life insurance go to their chosen beneficiaries.
Absolute Trust (also called a Bare Trust)
With an absolute trust, you need to individually name your beneficiaries and decide how much they’ll receive. This must be done when the trust is set up and you will not usually be able to change it later. So, if you have more children and grandchildren, or get divorced, you can't change the beneficiaries.
Flexible Trust
These trusts act like a mix of an absolute trust and a discretionary trust. You need to name at least one beneficiary – the default beneficiary. But you can also include discretionary beneficiaries. The default beneficiary will receive a payout from the trust. But the trustee can choose to make payments to any discretionary beneficiaries as well.
Split Trust
This type of trust is useful if you have life insurance with benefits that are payable during your lifetime like serious illness cover. You can put the policy in trust and the benefits will be split into those payable during your lifetime and those payable on your death. You can then receive the serious illness payment whilst you’re alive, and your beneficiaries receive the life insurance payout when you die.
Learn more about life insurance payouts.
How long does a trust last?
In the UK a trust can last up to 125 years. However, most trusts end well before that. It’s usually up to the trustee’s discretion when the trust ends.
Some trusts may need to be in place for a lifetime. For example, a trust set up for someone who lacks the capacity to look after their own finances. Other trusts, such as those set up to hold a life insurance policy may only be in place for as long as the policy is running.
An absolute trust set up for a child will end when the child reaches 18.
Life insurance in trust: pros and cons
Your life insurance policy can be worth a lot of money to your family. And just like any other asset, it is possible to put your life insurance in trust. Insurance companies usually provide you with the option to write your life insurance policy in trust when you take out your policy. However, you can choose to put the policy in trust at any time. And insurance companies don’t tend to charge you for doing this.
If you’re thinking about putting your life insurance policy in trust, there are pros and cons to doing so.
The benefits of putting life insurance into a trust
You decide who gets the money
When you set up a trust, you choose your beneficiaries. Then if you die while the plan is still running, the money will go to those people. If there’s no trust in place, the money may be diverted from your beneficiaries to pay outstanding debts.
Protected from inheritance tax
Because you don’t legally own the assets in a trust, they sit outside your estate for inheritance tax (IHT) purposes. This means they are not counted as part of your £325,000 IHT allowance. So, if you put your life insurance policy in trust, your beneficiaries will receive the full amount.
Learn more about life insurance and inheritance tax.
Quicker payout
A life insurance policy that is in trust doesn’t need to go through probate. Probate is the legal process of dividing up your assets amongst your beneficiaries. It can take many months for your assets to go through probate. With a life insurance policy that’s written in trust, however, the payout can be made within weeks.
The disadvantages of putting life insurance into a trust
Complexity
It can be tricky to understand the differences between the types of trust available, so it is a good idea to take legal advice about the best type of trust for your circumstances.
If you plan to put an existing insurance policy into trust, be careful that you don’t invalidate your insurance. Or cause inheritance tax problems for your estate. Again, taking legal advice could stop this from happening.
Can’t make changes
Although you may retain some influence over assets in a trust, you are effectively giving them away. Once you’ve made that decision, it cannot be reversed.
Trustees have control
Your trustees need to agree to any changes you want to make to the terms of the trust. Although you can be a trustee yourself, you won’t have sole control over decisions.
Can I change my mind?
Once you put a life insurance policy into trust, you cannot take it out again. You also cannot swap the type of trust you have chosen for a different one.
You can have some input into how the trust is set up and what it says through the trust deed and letter of wishes. After it's set up, you will not usually be able to make changes to it. Unless that is, you set up a revocable trust.
With these types of trust, you can change the terms of the trust at any time. You keep control over the trust, what’s in it and who benefits. But, they do not have the same inheritance tax advantages as irrevocable trusts. This is because you do not relinquish control of your assets in the same way.
Irrevocable trusts cannot be changed, except in very specific circumstances. You can say how you want the trust to be run in your letter of wishes, but the trustee makes all the decisions. However, these trusts sit outside your estate, so your estate won’t pay inheritance tax on the payout.
Can a joint life insurance policy be written into a trust?
Yes, a joint life insurance policy can be written in trust. Although, it isn’t necessary for inheritance tax (IHT) purposes, if the couple are married or in a civil partnership there is usually no IHT liability between spouses and civil partners.
For partners who aren’t married it can be useful to put a joint life insurance policy in trust. Naming your partner as a beneficiary makes sure they receive the money, not your estate.
Life insurance trusts and cohabiting couples
A trust provides security for cohabiting couples. It ensures that the partner receives the payout rather than the estate. There are no inheritance tax (IHT) allowances between cohabiting couples. So, if one partner dies and the life insurance policy isn’t in trust then it becomes part of their estate. This means it becomes liable for IHT and your partner may not receive the money you intended for them.
By putting your life insurance policy in trust, you can name your partner as a beneficiary. The money then sits outside of your estate and will be paid to your partner without the need to go through probate.
How to put life insurance in trust
Most insurance companies have trusts set up that you can choose when you take out your policy. You’ll need to agree to the terms of the trust by completing and signing the trust deed.
You’ll also need to appoint trustees and decide who your beneficiaries will be. The trustees take on the running of the trust and will make a claim for the policy when you die.
Should I put my life insurance into trust?
It very much depends on your personal circumstances and your family structure. Trusts can be very useful to make sure the person who you want to benefit from your plan actually does. They’re also an effective way to keep your life insurance payment out of your inheritance tax calculation.
You will need to carefully consider which type of trust is right for you. Speak to a legal adviser to make sure you have considered all the consequences of putting a life insurance policy in trust. Remember that once it’s done it can’t usually be undone.
Vitality life insurance
Want to know more about life insurance or thinking about taking out a policy? Here are some of the benefits of taking out life insurance with Vitality:
- A brand you can trust - In 2023, we paid out 99.7% of life insurance claims.*
- Get a lower monthly premium upfront when you add Optimiser to your plan. Keep your premiums low when you stay active.
- Access to Vitality partner discounts and rewards.
- Get free no-obligation advice. Our advisers offer expert advice to help you make the right decisions.
*Vitality Claims and Benefits Report, 2024
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