Pros and cons of putting a policy into a trust

If your client dies and their plan is not written in trust, Ian Smart, head of product development and technical support at Bright Grey and Scottish Provident, says their personal representatives will need to obtain the appropriate grant of representation before they can deal with the plan.

This process is known as ‘probate’ in England, Wales and Northern Ireland, or ‘confirmation’ in Scotland, and can take several months.

By putting your client’s plan in trust, he says clients can avoid the need for probate or confirmation, provided there is at least one surviving trustee following your client’s death. Because the trustees are the legal owners of the plan, they can deal with it immediately and make sure the funds are distributed as soon as possible.

Inheritance tax is currently payable at a rate of 40 per cent on any part of an estate valued at more than £325,000 (2013 to 2014).

When your client dies, Mr Smart says any money paid out from their protection plan is added to their estate. This means that your client may have to pay inheritance tax on their death even if their estate is worth less than £325,000 before the value of any plan has been added.

Setting up a trust means that your client is making a gift of some, or all, of the plan. This means that your client is removing that part of the plan from their estate so no inheritance tax is normally payable on it, so long as they do not die within seven years of setting up the trust.

However, Mr Smart warns some inheritance tax may still be payable following a claim if the plan proceeds are kept within the trust after the next 10-year anniversary of its establishment following the death occurring.

He says it is important to remember that in most cases once a policy is written in trust the trust is generally irrevocable and in most cases it is not possible to simply cancel the trust.

“It is therefore important when setting up the policy to consider carefully whether the policy should be taken out by one person or jointly and also the level of flexibility of the trust to be used. The most flexible solution is always to have single-owner plans and to use the appropriate version of the discretionary trust.

“It is also important to choose your trustees wisely. These are the people who will administer the trust and will be able to make decisions about who will benefit and when. It is vital that you keep in touch with these people so they can be contacted when there is a claim or if their circumstances change so that this can be taken into account when deciding whether they should remain as a trustee.”

Esther Dijkstra, head of intermediary protection propositions at Scottish Widows, points out proceeds from a policy placed in a trust can be used to provide funds to pay for inheritance tax on death.

A trust can also provide business continuity in the event of the death of another share-holding director or partner. However advisers and their clients should always remember that by placing a policy in trust the client no longer owns it as ownership is transferred to the trustees.

Chris McNab, protection product manager of LV, points out this means if the client wants to make changes to the protection policy – such as increase or reduce cover – then unless they are also a trustee they cannot do this.

“It is important to consider if the client wants this flexibility, and if they do they should make sure that any trust deed they use includes them as a trustee.

“Also most trusts will exclude the settlor (the person who originally owned the policy and put it in trust) as being a beneficiary. This isn’t a problem if the client is the only settlor, but it can present a problem if a couple have taken out joint life first death insurance as this would prevent the survivor from receiving the proceeds.

“However there are trusts around that include a ‘survivorship option’ which means that if one settlor survives the other then the proceeds are paid to the surviving settlor rather than to the beneficiaries named under the trust deed.”

Ultimately, Mr McNab points out placing a policy in trust is an irrevocable decision. He warns this means that if a policy is written in trust, the client cannot simply change their made and take the policy back out of trust later on.