Life Assurance Policies

Partner Antony Caulfield

Antony Caulfield, Private Client Partner, discusses tips and traps of life assurance policies.

  • Tips and traps

When I see clients to discuss preparing Wills and to consider inheritance tax planning, the question of life assurance often comes up and clients are often unaware of what their policies provide and the potential inheritance tax and other benefits of writing these policies into trust, as well as the importance of keeping any existing arrangements under review, if circumstances change.

Where a life policy is owned by an individual, then on that person’s death, the policy proceeds will pay out to their estate and therefore the proceeds could potentially be subject to inheritance tax at 40%, unless written into trust. Many insurance companies will often have standard trust documentation, which you can request from them, to write the policy into trust. There are usually several options such as writing the policy into trust for one or more individuals absolutely on death, or alternatively, often the policy proceeds can pass into a flexible discretionary trust, which offers more flexibility as to when and how the policy proceeds are paid out to your beneficiaries, which can be important, if your circumstances change in the future. It is often sensible to consult with your solicitor, financial advisor, or tax advisor, as to what is the best and most effective way to write a policy into trust, to reflect your wishes and current circumstances and to also advise if there are any tax considerations.  If the insurance company does not have any standard trust documentation, or their standard documents do not meet your requirements, then we can usually assist in preparing a suitable trust deed for you.

Writing the policy proceeds of a life policy into trust not only ensures those policy proceeds are outside of your estate for inheritance tax, but also helps to keep the value of your estate down, which can preserve your entitlement to other important inheritance tax reliefs, such as the residence inheritance tax nil rate band. This important allowance is reduced and tapered back, by £1 for every £2, a person’s estate exceeds £2million.

Other benefits of writing a life policy into trust include that your beneficiaries will not have to wait for a Grant of Probate to your estate, which usually takes several months to obtain, in order to receive the funds. This will ensure the policy monies are available quickly for your chosen family members to assist with paying funeral expenses, or to meet your inheritance tax bill, if your estate is subject to inheritance tax.

If you write a life policy into trust and continue to pay the regular premiums on the policy, these payments will be considered a gift for inheritance tax purposes, but will often be exempt if the total premiums fall within your annual £3,000 annual inheritance tax allowance, or alternatively form part of your normal expenditure out of surplus income.

It is commonplace, when taking out a mortgage, to also take out a term assurance life policy at the same time, to ensure the mortgage is paid off in full, in the event of death, before the end of the mortgage term. Where a couple are purchasing a property together, these policies will often be taken out on a joint life, first death, basis. Where this is the case, this will mean that the policy proceeds will pay out on the death of the first joint owner of the policy, to the surviving joint owner. If a couple subsequently separate, consideration should be given as to whether either of the parties wish to continue with and take over responsibility for the policy and if so, a formal Deed of Assignment should be prepared to ensure that the full benefit of the policy is assigned to the person taking over sole responsibility for the policy,  as otherwise the other original joint owner of the policy will still benefit from it, in the event of the other party’s death. We can assist in preparing any required Deed of Assignment.

Certain types of life assurance policy, commonly known as investment bonds, will result in a chargeable event arising on death, which can sometimes lead to a large income tax liability in the year of death, as this chargeable event is treated as the top slice of the deceased’s income and in the event that this takes them into a higher rate tax bracket will mean that an additional income tax charge will arise, which will need to be paid from their estate.  This can often be avoided if the policy is set up with multiple lives assured and with a flexible trust arrangement, which can allow the policy to be assigned to one or several different beneficiaries, prior to encashment, to mitigate, or avoid altogether, any additional income tax charge arising.

If a flexible trust arrangement is used, for a life policy, you should review the trust documentation regularly, in the same way as you review your Will, to ensure that no changes are required, as often with a flexible trust arrangement it may be possible to add new beneficiaries and remove trustees, if circumstances change, such as if you get divorced and subsequently re-marry. If you are looking to alter your existing trust arrangements, we are able to advise if this is possible and if so prepare any necessary documentation.

In summary, writing life assurance policies into trust, can have important inheritance tax and other benefits, such as ensuring funds are available to your loved ones, quickly after death, without having to wait for a Grant of Probate. If you are considering writing these policies into trust you should take advice on the options available and to check there are no other tax or other considerations. Once set up you should ensure the trust arrangements are reviewed regularly, in the same way as you review your Will, to ensure they still meet your requirements and that no changes, such as a change to one of the trustees, are necessary.

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