When a life insurance policy pays out, the proceeds are treated as part of the deceased’s estate for inheritance tax (IHT) purposes. If the estate exceeds any available nil rate bands and is therefore subject to IHT, almost half of the life insurance proceeds goes to HMRC.
HMRC recently reported that in 2016/17, they received £300 million of IHT from life insurance policies. This is a huge amount of money considering this IHT charge can be avoided by writing the policy into trust for the benefit of your heirs. Given that it is one asset which doesn’t get used during our lifetimes (any critical illness portion can be separated out and kept), it is an ideal candidate for gifting – and if done correctly it is treated as perfectly acceptable by HMRC.
Furthermore, the trust does not need to be set up at the same time the policy is. In fact, an existing policy can be written into trust at any time, so it is not too late to do this now – although the process is different and if not done from the start there may be a 7 year survivorship requirement which could otherwise have been avoided.
There is a risk. Life insurance companies usually provide standard documentation to write policies into trust, with a view to saving initial costs and making it quick and easy. Unfortunately for some families, it can be done too quickly and creating a Trust isn’t quite as simple as the company implies. As a result, we see many policies which are invalid as Trusts, due to minor errors in completing the company’s forms, so that IHT is still paid on the proceeds. Naturally, the company bears no liability for this. HMRC ask to see the trust documents of life insurance policies because they know this is so often the case. By then, however, it is too late to correct the oversights. A relatively short meeting with your solicitor when you first set up the policy, to get help completing those “standard forms” can save a lot of money further down the line.
It is important that writing the policy into trust suits your needs, as well as saving IHT for your family. If the survivor of a couple will need the policy proceeds to pay debts, and funeral expenses, it may be best to leave the policy as it is. However, if your intention is for the proceeds to benefit your heirs, or provide ready funds to pay the IHT, then writing the policy into trust ensures that they will receive all the proceeds rather than 60% of it (after 40% IHT).
If you need help deciding whether writing your life insurance policy into trust would be beneficial for tax purposes and how to go about doing this, please contact Carolyn Bagley by clicking here