With recent and upcoming shifts to Inheritance Tax (IHT) and pension rules, careful estate planning is more crucial than ever for those looking to secure their loved ones’ financial future.
Among the most effective strategies to consider is writing your life insurance policy into a trust.
This can offer significant advantages, greater control over your assets, and could mean that your beneficiaries will have faster access to their funds.
It can be a complicated landscape to navigate, so here’s what you need to know about writing life insurance in trust.
The evolving landscape of Inheritance Tax
The UK’s IHT landscape is undergoing notable changes, and some have occurred already. From April 2025, the domicile and deemed domicile rules were replaced by new long-term UK resident rules. This could bring more non-UK assets into the IHT net.
Additionally, the nil-rate band and residence nil-rate band remain frozen until 2030. These are £325,000 and £175,000 respectively.
This means that, as assets and property values rise, more estates could become subject to IHT.
Perhaps most significant, however, is that from April 2027, most unused pension pots and death benefits payable from most pensions are set to be included in your estate for IHT purposes.
This marks a substantial departure from the current pension exemption and makes it vital to reevaluate how you are holding your wealth.
If you had placed a substantial amount of your wealth into your pensions to avoid IHT, this could prove to be costly for your beneficiaries.
The Inheritance Tax advantage of trusts for life insurance
Normally, a life insurance payout would form part of your estate upon death. This could increase its value above the IHT threshold and thus make a portion of it subject to the 40% rate. However, by writing your life insurance policy into trust, the proceeds can be excluded from your taxable estate.
Here’s why this could be valuable for you:
- Exclusion from your estate. When a life insurance policy is placed in trust, the legal ownership of the policy is transferred from you to your trustees. This means that when you pass, the payout does not form part of your estate for IHT purposes, allowing your beneficiaries to receive the full sum without any IHT deductions.
- Providing liquidity for IHT. Even if other assets in your estate are subject to IHT, and sometimes this is unavoidable, life insurance could provide vital liquidity for your loved ones. This can prevent the need to sell valuable assets, such as property or investments, to pay the tax bill.
- Addressing gifts and taper relief. If you’ve made significant gifts within seven years of your death, these could still be subject to IHT under the “taper relief” rules. A life insurance policy in trust can be useful for covering any potential tax liability that may arise.
Beyond the IHT benefits, writing your life insurance into trust can offer further practical advantages for your loved ones.
You can specify who you want to benefit from your life insurance policy and under what circumstances. This can be particularly useful if you have children under 18, vulnerable beneficiaries, or specific wishes regarding how you want the funds used.
Moreover, without a trust, a life insurance payout typically becomes part of your estate and must go through the probate process. This can be lengthy, often taking months, and could delay crucial funds for your beneficiaries.
Different types of trusts
The type of trust you choose will affect the level of flexibility and control you have. There are a variety of options, including:
- Absolute trusts: These are the most straightforward and are sometimes also called bare trusts. Here, you name specific beneficiaries who have a fixed right to the policy’s proceeds. Once established, you cannot change the beneficiaries.
- Discretionary trusts: These provide the most flexibility. With discretionary trusts, you name a class of potential beneficiaries, but the trustees have the discretion to decide who receives the funds, how much they receive, and when. This means you can adapt your plans as circumstances change. While you will lose control over how the money is distributed, you can provide a letter of wishes to guide your trustees.
- Flexible trusts: These offer a blend of both absolute and discretionary trusts. You would name a “default” beneficiary (or beneficiaries) who will receive the funds. However, they can be replaced by discretionary beneficiaries at any time.
While trusts can be useful, they can also be complicated, and it’s easy to make mistakes. You may wish to consider taking specialist advice before using trusts as part of your estate plan.
The importance of financial advice
While the benefits of writing life insurance into trust are clear, the complexities of IHT, pension changes, and trust laws typically benefit from expert guidance. The right type of trust for your circumstances, along with its correct execution, is key to ensuring your wishes are met and that there are no unintended consequences.
A financial planner can help you manage this by:
- Assessing your overall estate and potentially IHT liability
- Working out what the most suitable type of trust would be for your needs
- Guiding you through the process of setting up the trust and appointing trustees
Integrating your life insurance trust seamlessly into your broader estate plan
In an increasingly complicated financial world, proactive planning is key to protecting your financial legacy. By understanding the significant advantages of writing your life insurance policy into trust, you can take an important step towards ensuring your loved ones are financially protected and your wealth is passed on according to your wishes.
Get in touch
Navigating the world of IHT is one of our specialities, and we’re here to help you. Talk to us today to find out how we can develop a personalised plan suited to your needs and circumstances.
Email info@doddwealthcare.co.uk or call 01228 530913 / 01768 864466 to learn more.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, trusts, or will writing.
