As the new year prompts a surge in financial planning, a stark warning has been issued to families across the UK: a common oversight with life insurance could see loved ones hit with a hefty 40 per cent tax bill and endure months of waiting for vital funds.
The Hidden Tax Trap in Life Insurance
Research conducted by the comparison site MoneySuperMarket reveals a concerning knowledge gap. It found that one in five people are unaware that payouts from life insurance policies are typically included in calculations for Inheritance Tax (IHT) if the policy is not correctly structured.
This tax is levied at a rate of 40 per cent on the value of an estate that exceeds the nil-rate band, which is currently frozen at £325,000. For many households, the lump sum from a life insurance policy could easily push the total estate value over this threshold, triggering a significant tax charge that the policy was meant to help alleviate.
Probate Delays and Financial Strain
The potential financial shortfall is not the only concern. Without proper planning, the insurance payout must go through the probate process before beneficiaries can access the money. This legal and administrative procedure for validating a will can take many months to complete, leaving grieving families in a precarious financial position at a time when they are most vulnerable.
Kara Gammell, a personal finance and insurance expert at MoneySuperMarket, emphasised the impact: “With a trust, you get to control what happens to your life insurance. Putting your life insurance policy in trust can make a big difference for your loved ones. It means the payout usually bypasses probate, so your family can access the money faster at a time when they may really need it.”
The Simple Solution: Writing Policy into Trust
The effective solution to both the tax and delay issues is remarkably straightforward. By placing a life insurance policy into a legal trust, the payout is separated from your estate for IHT purposes. This means it is not counted towards the £325,000 threshold and can be distributed without waiting for probate to conclude.
The process is simpler than many assume. It begins by requesting a trust form from your insurance provider. As Gammell notes, “Setting up a trust is quicker and easier than most people think, and many providers offer this service for free.”
When completing the form, you will need to appoint trustees—responsible individuals who will manage the trust—and name your beneficiaries, such as children or a partner. A key advantage of a trust is the ability to set conditions, for instance, stipulating that young children cannot access a large sum until they reach a specified age.
The final step is to sign and return the form to your insurer. MoneySuperMarket strongly advises policyholders to then confirm in writing that the trust is officially in place. This one extra form, often free to complete, could safeguard tens of thousands of pounds for your family's future, ensuring your intended financial safety net functions as you hoped.
