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If you have a life insurance policy and die without placing it in trust, the payout falls into your estate — and may face IHT at 40% before reaching your family. Writing the policy in trust removes the payout from the estate entirely, ensuring your beneficiaries receive the full amount.
Life insurance in trust is one of the simplest IHT planning tools available. It does not reduce the IHT on the rest of the estate, but it can provide liquid funds to pay the IHT bill — which is often a more immediate practical concern than the size of the bill itself.
Where a life policy is payable to the policyholder's estate, the payout on death goes to the estate and forms part of the assets HMRC assesses for IHT. If the estate exceeds the available nil-rate band (£325,000, plus any transferred band and the residence nil-rate band where it applies), the payout is taxed at 40% like any other asset.
For a £500,000 life policy included in a taxable estate, the IHT on that payout alone could be up to £200,000 (£500,000 × 40%). Writing the policy in trust before death eliminates that liability entirely.
There is also a timing problem. Where the proceeds are payable to the estate, the insurer will usually require the grant of probate before releasing anything above its own small-payment limit, and that takes time. Meanwhile the inheritance tax on the estate has to be paid before the grant is issued — though tax on land and certain business assets can be paid in ten yearly instalments, and HMRC's direct payment scheme allows banks to release funds from the deceased's own accounts to pay it. Proceeds held on trust are paid to the trustees, who do not need the grant.
When you write a policy in trust, you (the "settlor") transfer ownership of the policy to trustees. The trustees hold the policy and any proceeds on behalf of the beneficiaries you have named. On death, the insurer pays the payout directly to the trustees — not to your estate. Because the policy never forms part of your estate, there is no IHT on the payout.
The most common trust structures for life policies are:
Life insurers generally provide their own trust deed, either as part of the policy application or for an existing policy. The process is typically:
For an existing policy, writing it in trust is treated as a gift to the trust. If the policy has a surrender value at that point, the gift has a value for IHT purposes. For most term policies (which pay out only on death), there is no surrender value and no IHT consequence. Whole-of-life and investment-linked policies may have a surrender value, so the transfer into trust is a transfer of value equal to that amount. Into a discretionary trust it is a chargeable lifetime transfer; into a bare trust it is a potentially exempt transfer.
One condition runs through all of this: the settlor must be excluded from benefiting under the trust. A settlor who can still benefit from the policy or its proceeds has made a gift with reservation, and the proceeds come back into their estate on death — which is the outcome the trust was set up to avoid.
A whole-of-life policy pays out whenever death occurs — there is no fixed term. That matches an IHT liability, which also arises whenever death occurs. Premiums are higher than for term insurance. Whether the cover is certain depends on the policy: a guaranteed premium whole-of-life policy pays out provided premiums are maintained, while a reviewable premium policy is repriced periodically and can become unaffordable, in which case the cover ends.
For married couples, a joint life second death policy pays out on the second death — when IHT typically first becomes due (due to the spouse exemption on first death). The premium is lower than two separate policies and the timing matches the point at which the IHT bill arises.
A gift inter vivos policy is a seven-year decreasing term policy sold to cover the potential IHT on a large lifetime gift placed on the 7-year clock. Cover runs for seven years and then ends, at the point the gift falls out of the estate. Such policies usually decrease in line with taper relief, which is worth understanding before relying on the shape of the cover: taper reduces the tax charged on the gift, not the value of the gift, and it only applies where the gifts made in the seven years before death exceed the available nil-rate band. Where they do not, there is no tax on the gift to taper and the tapering shape of the cover matches nothing.
Premium payments on a life policy written in trust are technically gifts to the trust each time they are paid. For most people:
In practice, most life insurance premiums are modest enough to fall within the annual or normal expenditure exemptions, so this is rarely a problem.
A policy in trust does not reduce the IHT on an estate — it provides a fund outside the estate that the family can use to pay the bill. The measures that reduce the bill itself are separate:
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