Thinking about what will happen when you’re gone is one of the hardest parts of financial planning – but it’s also one of the most important. If you’ve got a partner or kids, you’ll want to make sure they can afford to get by without you. That’s probably the main reason why you might think about life insurance.
But what will happen to your life insurance policy when you pass away? Will your dependants have to pay tax on the pay-out? They might do – if you don’t put your life insurance policy into a trust. Let’s find out what this means.
Policy ‘in trust’
A trust is when you set out who you want your life insurance pay-out to go to after your death. You legally set up ‘beneficiaries’ and they will automatically get the money from your policy if you die while it’s still active. This could be your partner, your children if they’re over 18 or any other relatives.
The main benefit of putting a life insurance policy in trust is that it can help your loved ones to avoid inheritance tax (IHT). When you pass away, everything you own – including your home, your car and any money – is your estate. If your estate is worth more than a total of £325,000, your will executor pays 40% of everything over the threshold.
But life insurance policies in trust aren’t included in your estate. They’ll automatically go straight to whoever you’re leaving it to. This could mean your estate won’t go over the IHT threshold – so there’s no tax to pay.
If you’ve got a joint life insurance policy and you want to set up a trust, you’ll need to do this together.
And if you want to cancel the trust for any reason – if you split up with your partner, for example – this can be tricky. That’s why you should only set up a trust if you’re really sure you know who you want your life insurance pay-out to go to.
If it’s not in trust
If your life insurance policy isn’t in trust, your loved ones might find they get a reduced pay-out when you’re gone. This is because your policy will be included in your estate, so it might be subject to IHT.
Leaving your life insurance policy out of a trust can also mean your loved ones could have to wait to get the pay-out. This is because when you die, your whole estate will go through ‘probate’. Probate is a legal process to share all of your possessions between your relatives. If you have a will, this can take a few weeks but if you don’t have a will, it can take even longer.
So if your family is relying on your estate to help them pay for the mortgage or other household costs, they might start to struggle. Putting your policy in trust means the pay-out can go to your loved ones faster so they can get the money they need without a wait.
Setting it up
It’s really easy to set up a trust for your life insurance – you can do it for free through your insurance provider when you set up the policy. If you set up Life Insurance with us, our customer care team can help you put your policy in trust. There’s no extra charge for this so if you want to make sure your pay-out goes to the right people, it’s worth considering. But as with anything to do with financial planning, it’s a good idea to speak to a financial expert before you make any decisions.