Life Insurance in Trust and Inheritance Tax
A life insurance payout can push your estate well above the inheritance tax threshold, costing your family up to 40% of the proceeds. Writing the policy in trust is one of the simplest and most effective ways to keep that money out of HMRC's reach. Here is how it works, when to do it, and what to watch out for.
Note: This article is for educational purposes only. Life insurance and trust arrangements should be set up with advice from a qualified financial adviser or solicitor. The examples use simplified figures to illustrate concepts.
Life Insurance in Trust — Key Points
Why Regular Life Insurance Creates an IHT Problem
When you take out a life insurance policy in your own name, the payout on death becomes part of your estate. If your estate already exceeds the nil-rate band (£325,000, or up to £500,000 with the residence nil-rate band), the insurance payout is taxed at 40%.
This is particularly painful because many people buy life insurance specifically to provide for their family after death — yet without a trust, a significant portion goes straight to HMRC instead.
Margaret has an estate worth £450,000 including her home. She has a £300,000 whole-of-life policy in her own name to provide for her two children.
| Component | Value |
|---|---|
| Estate (property, savings, etc.) | £450,000 |
| Life insurance payout | £300,000 |
| Gross estate | £750,000 |
| Less: NRB + RNRB | −£500,000 |
| Taxable amount | £250,000 |
| IHT at 40% | £100,000 |
Without the life insurance, Margaret's estate would be below the combined NRB and RNRB threshold. The insurance payout alone creates a £100,000 tax bill.
How Writing in Trust Changes Everything
When a life insurance policy is written in trust, the policy is legally owned by the trustees — not by you. On your death, the payout goes directly to the trust beneficiaries. Because you do not own the policy, its value is not part of your estate.
The benefits are significant:
- No IHT on the payout: The proceeds are outside your estate entirely
- No probate delay: Trustees can claim the payout immediately without waiting for a grant of probate, which can take months
- You choose the beneficiaries: The trust deed names who receives the money, giving you control over distribution
- Protection from creditors: Trust assets are generally protected from claims against your estate
Margaret places the same £300,000 policy in trust for her two children.
| Component | Value |
|---|---|
| Estate (property, savings, etc.) | £450,000 |
| Life insurance payout | Outside estate |
| Gross estate | £450,000 |
| Less: NRB + RNRB | −£500,000 |
| Taxable amount | £0 |
| IHT at 40% | £0 |
The children receive the full £300,000 from the trust plus the estate passes tax-free. Total saving: £100,000.
Types of Trust for Life Insurance
The two main trust types used for life insurance are absolute trusts and discretionary trusts. Each has different trade-offs.
Absolute (Bare) Trust
- Beneficiaries are fixed when the trust is set up and cannot be changed
- Each beneficiary has a defined share (e.g., 50/50 between two children)
- Simpler to administer — no trustee discretion required
- No periodic or exit charges
- Beneficiaries have an absolute right to the funds once they reach 18
Best for: Families with a clear, fixed set of beneficiaries who are unlikely to change.
Discretionary Trust
- Trustees decide who benefits, when, and how much
- You can name a wide class of potential beneficiaries
- Flexibility to adapt to changing family circumstances
- May face periodic charges (every 10 years) and exit charges if trust value exceeds the NRB
- More complex to administer
Best for: Families where circumstances may change — for example, if you want trustees to consider grandchildren who have not yet been born, or if you want to protect a beneficiary from creditors or a divorce settlement.
| Feature | Absolute trust | Discretionary trust |
|---|---|---|
| Beneficiaries | Fixed | Flexible |
| Can change beneficiaries | No | Yes |
| Periodic charges | No | Yes (if over NRB) |
| Trustee discretion | None | Full |
| Complexity | Low | Higher |
| Typical use | Known beneficiaries | Flexible family planning |
Comparison of trust types for life insurance
Worked Example: £500,000 Policy In vs Out of Trust
David, 62, has a whole-of-life policy worth £500,000. His estate (excluding the policy) is worth £800,000 including his home, which qualifies for RNRB. He is widowed and leaves everything to his two children.
| Component | Value |
|---|---|
| Estate assets | £800,000 |
| Life insurance payout | £500,000 |
| Gross estate | £1,300,000 |
| Less: NRB (own + transferred) | −£650,000 |
| Less: RNRB (own + transferred) | −£350,000 |
| Taxable amount | £300,000 |
| IHT at 40% | £120,000 |
| Component | Value |
|---|---|
| Estate assets | £800,000 |
| Life insurance payout | Outside estate |
| Gross estate | £800,000 |
| Less: NRB (own + transferred) | −£650,000 |
| Less: RNRB (own + transferred) | −£350,000 |
| Taxable amount | £0 |
| IHT at 40% | £0 |
By placing the policy in trust, David's children receive the full £500,000 payout and the estate passes IHT-free. The trust saves £120,000 in inheritance tax.
How to Set Up a Trust for Life Insurance
Setting up a trust for a new policy is straightforward:
- When taking out the policy: Ask your insurer for a trust form. Most providers offer standard absolute and discretionary trust deeds at no extra cost.
- Choose your trust type: Absolute if beneficiaries are fixed, discretionary if you want flexibility.
- Name your trustees: You will typically be one trustee yourself. Appoint at least one additional trustee (often a family member or solicitor) who can act after your death.
- Name your beneficiaries: For an absolute trust, specify each person and their share. For a discretionary trust, define the class of potential beneficiaries.
- Sign and return the trust deed: The insurer registers it and the policy is held in trust from that point.
Placing an Existing Policy into Trust
You can also place an existing policy into trust, but there are important considerations:
- Term insurance (no surrender value): Usually no transfer of value, so no immediate IHT implications
- Whole-of-life or investment-linked policies: The surrender value at the date of transfer is treated as a gift. If it exceeds the NRB (£325,000), there may be an immediate 20% entry charge for discretionary trusts
- The transfer is a potentially exempt transfer (PET) for absolute trusts or a chargeable lifetime transfer (CLT) for discretionary trusts
If you are in poor health when you place a policy into trust, HMRC may argue this was a “gift made in contemplation of death” and challenge the arrangement. Set up trusts while you are in good health.
Important Caveats
While writing life insurance in trust is a powerful planning tool, there are some important points to keep in mind:
- You lose control: Once the policy is in trust, it belongs to the trustees. You cannot change your mind and take the money back (though you can usually change beneficiaries in a discretionary trust).
- Premium payments: If you pay premiums on a policy held in trust, the premiums are treated as gifts. They are usually covered by the annual exemption (£3,000/year) or the normal expenditure from income exemption. Larger premiums may become PETs or CLTs.
- Joint life policies: For married couples, a “second death” (last survivor) policy in trust is often most efficient, since there is no IHT on the first death due to the spouse exemption.
- Mortgage life insurance: Policies that pay off a mortgage on death are typically assigned to the lender, not held in trust. These reduce the estate value rather than adding to it.
- Employer death-in-service benefits: These are usually already held in a trust by the pension scheme, so they are already outside your estate. Check with your employer.
Frequently Asked Questions
Does life insurance count as part of your estate for inheritance tax?
Yes, if the policy is in your own name the payout is added to your estate and taxed at 40% above the nil-rate band. Writing the policy in trust removes it from your estate entirely, so the proceeds go directly to your beneficiaries free of IHT.
How do you write a life insurance policy in trust?
Most insurers provide a standard trust form when you take out the policy. You complete the trust deed naming your beneficiaries, and the insurer registers it. You can also place an existing policy into trust, though this counts as a transfer of value for IHT purposes if the policy has a surrender value.
What type of trust should I use for life insurance?
An absolute (bare) trust is simplest — beneficiaries are fixed and cannot be changed. A discretionary trust gives trustees flexibility to decide who benefits and how much they receive. Discretionary trusts are more flexible but may face periodic and exit charges if the trust value exceeds the nil-rate band.
Can I put an existing life insurance policy into trust?
Yes, but if the policy has a surrender value at the time of transfer, that value is treated as a gift for IHT purposes. If it exceeds the nil-rate band, there may be an immediate 20% entry charge. Term policies with no surrender value can usually be placed into trust with no transfer of value.
Is there a cost to writing life insurance in trust?
Most insurers offer standard trust forms at no extra cost when you take out the policy. If you need a bespoke trust deed drafted by a solicitor, expect to pay £500–£1,500. There is no ongoing cost for the trust itself, though trustees have administrative responsibilities.
Do I still pay the premiums if my life insurance is in trust?
Yes, you continue paying premiums as normal. The premiums may qualify as exempt transfers for IHT purposes — either under the annual exemption (£3,000 per year), the normal expenditure from income exemption, or as potentially exempt transfers that fall out of your estate after seven years.
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