Getting a trust
Life insurance pays out if your spouse dies during the length of the policy. But if you don’t set up a trust to receive these payments, you could lose a big chunk of your estate in inheritance tax.
Inheritance tax is levied on the estate of someone who dies. This includes property, money and possessions.
There’s no inheritance tax to pay if you leave everything to your spouse or civil partner. Or if the estate is worth less than a threshold figure after debts and funeral expenses have been paid.
But when your life insurance policy pays out, it could push the value of the estate over the threshold figure.
The inheritance tax allowance threshold is £325,000 per person but it rises to £450,000 if you pass on a home to your spouse or children. An individual’s allowance is also passed on, giving a couple a combined allowance of £900,000.
Let\’s simply this
Let’s say that a couple, Alex and Bob, have an estate worth £700,000. They also have a life insurance policy that pays out £400,000 when one of them dies.
If Alex dies first, the insurance policy pays Bob and the estate is then worth £1.1 million. Bob pays nothing at this point, because he was left everything in Alex’s will.
But what happens when Bob dies? Assuming the estate is still worth the same amount, inheritance tax is due on the difference between £1.1 million and the inheritance tax threshold of £900,000 – that’s £200,000.
Since inheritance tax is charged at 40%, that’s a whopping £80,000 to the Inland Revenue. That\’s money that Bob hoped his family and friends would receive from him – but never will.
Is there a way around this?
The way around this is to write the life insurance policy into a trust. That way, the policy pays out into the trust, which effectively forms a wrapper to protect it against inheritance tax.
In the example above, Bob’s heirs would inherit an estate worth £700,000. That’s below the threshold figure so there is no inheritance tax to pay.
But if they are also named as beneficiaries of the trust, they will receive the money from the life insurance policy from the trust – with no inheritance tax to pay.
All you need to do is set up a trust, which is administered by trustees of your choosing – usually family members or friends – when the time comes.