You are likely aware of the benefits of taking out a life insurance policy, but what are perhaps less well-known are the advantages of putting that policy in trust.

This is a strategy that has long been useful in estate planning but is becoming increasingly popular and valuable in the light of recent reforms to Inheritance Tax (IHT).

While it’s not suitable for everyone, doing so can help mitigate IHT and provide a significant boost to your beneficiaries.

Read on to find out why putting life insurance in trust could be beneficial for your estate plan.

HMRC typically excludes assets held in trust from your estate for IHT purposes

Assets placed in trust usually fall outside your estate for IHT purposes, which means they are not counted when HMRC calculates how much tax is due.

So, if you put your life insurance policy in trust, the payout can go directly to your chosen beneficiaries. This avoids both IHT and the delays that often come with probate.

The lump sum from a policy payout can provide support to your loved ones and help them cover key expenses at a difficult time, and almost all policies do pay out. According to Forbes, around 97% of policies paid out in 2024.

If the policy is not in trust, the payout is normally treated as part of your estate and could face an IHT charge of 40%.

The impact of this can be significant. A report in Insurance Business found that of the 31,500 estates that paid IHT in 2022/23, almost a quarter included life insurance policies. Together, those policies were worth £865 million, meaning up to £346 million may have been lost to tax, which amounts to nearly £50,000 per estate. If those policies had been written in trust, they wouldn’t have been charged IHT.

However, there are some important points to be aware of. For example, if you die within seven years of placing a policy in trust, HMRC may still treat it as part of your estate.

You also need to pay premiums from surplus income. When they are treated as “normal expenditure out of income”, they are usually exempt from IHT. But if you have to use other capital to pay them, the payments could be classed as gifts and potentially become liable for IHT.

With Inheritance Tax revenue rising, this strategy could be increasingly useful

Statista figures show that IHT receipts have reached record levels for four consecutive years. In fact, since 2010/11, the only years that did not set a new record were between 2019 and 2021.

One of the main drivers behind this rise is the long-term freeze on IHT thresholds, which was recently extended to 2031, meaning the standard nil-rate band will have remained unchanged for 22 years. As property prices and investment values continue to rise, more estates are gradually being pulled into the IHT net.

Further changes are also on the way. From 2027, pensions will fall within the scope of IHT. As a result, many people are now rethinking their estate plans, particularly those who have relied on pensions as a key part of their legacy planning.

While there are several ways to improve the efficiency of the pension you pass on, one option is to use your pension income to fund a life insurance policy written in trust. In effect, this moves money out of your pension and into a policy that can pay out to your beneficiaries free of IHT.

That said, this approach isn’t right for everyone. Premiums can be expensive, and redirecting pension income may affect your own standard of living in retirement. There are also other factors to consider, so it’s important to speak to a financial planner before making any decisions.

You can read about the upcoming changes to IHT in our previous article on the topic.

A financial planner can help you choose the right life insurance policy and trust

A financial planner can make sure you pick the right life insurance policy and set up a trust that fits your circumstances.

When it comes to life insurance, there are two main types to consider:

• Whole-of-life assurance – This is generally the most effective choice for estate planning, as it guarantees a payout whenever you pass away, provided premiums are kept up to date.
• Term assurance – This only provides coverage for a set period, which may not always align with your long-term estate planning goals.

Choosing the right type of trust is equally important. There are multiple options available, and a financial planner can help ensure the trust you choose is suitable for your policy and your goals.

Get in touch

To find out more about whether putting life insurance in trust could be a good decision for you, get in touch.

Email info@blueskyifas.co.uk or call us on 01189 876655.

Please note

This article is for general information only and does not constitute advice. The information is aimed at individuals only.

All information is correct at the time of writing and is subject to change in the future.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.