Losing a partner or parent is one of life’s most daunting experiences, but fighting for a life insurance payout at the time when it’s most needed can make it so much worse.
Yet this is the reality faced by many who are grieving for a loved one.
This can be easily avoided if you know how. A life insurance policy written on credit should not only pay off quickly, but also avoid ending up as part of your estate and subject to inheritance tax.
Sometimes life coverage payments are transferred to your estate, increasing its value and possibly even exceeding the inheritance tax minimum.
If you buy a life insurance policy online or from an insurance company you pay outright each month, and the assumption is that when you die, it’s paid out to your partner or children so they don’t have to worry about funeral expenses, mortgage payments or monthly bills.
However, it rarely works out that way: Insurance companies can take months to process a claim and pay your family the money, leaving them high and dry at an already difficult time.
Even worse, sometimes life insurance payouts are made into your estate which includes the value of your home, which can result in you exceeding the £325,000 inheritance tax limit.
That can leave your loved ones with a bill for 40 percent of anything over that amount.
But there’s a simple way to avoid this: Placing a life policy in trust allows the policyholder to designate anyone they wish as a beneficiary of the trust, meaning your family gets a lump sum upon death without the worry of a huge inheritance. tax bill.
Phil Guinness, of protection comparison site UnderwriteMe, explained, “A trust is simply a document that tells people what you want to do with your money once you’re gone.
“It cuts out all the legal delays that often occur when distributing someone’s property and means insurance companies know who to pay and how much.”
Financial advisors should be able to easily set up a life cap in this structure but many do not unless you specifically ask them.
Inheritance tax is payable if a person’s estate (his estate, money and property) was worth more than £325,000 at his death.
This is called the inheritance tax threshold.
Spouses and civil partners can pass on the Unused Survivor’s Benefit, which effectively doubles the maximum to £650,000.
The chancellor also revealed plans for a new zero-rate homestay band starting at £100,000 in 2017 and rising to £175,000 by 2020 for those leaving their home to a direct descendant.
There are different limits for previous years that you can view here.
The inheritance tax rate is 40 percent on anything above the minimum.
The rate can be reduced to 36 percent if 10 percent or more of the estate is left to charity.
Calculate the value of someone’s estate.
Currently, only one in ten policies is written into a trust.
Mark Locke, protection specialist at financial services advisory The Lang Cat, said this may be because most advisors charge a fee for financial planning when placing policy in a trust. There may also be legal advice to pay for.
He said: ‘When most people buy life insurance they look for the cheapest deal and that’s why they don’t always think about the consequences of not putting it in trust.
If you take out life insurance, the reason is that you care about your family’s financial security should they no longer be around—and for that reason alone, it’s worth having a conversation with your advisor about how best to achieve that goal. “
If the cash to cover your life is supposed to go to your spouse and children, the trust makes sure of that without undue delay.
‘You can put any protection cover in a trust but life insurance is most suitable,’ Jeynes said. It is very easy and requires minimal paperwork. Speak to your advisor or contact the insurance company directly. You don’t need to change the policy itself or take any new cover.
Legacy: Trusts can be used to pay children’s or grandchildren’s school fees
Placing a cap on the life of the trust also allows large payments to be made to others more easily. For example, grandchildren could be beneficiaries to remove future inheritance tax payments and to meet specific needs such as school fees.
It also guarantees a definite result without the intervention of will.
Alan Lucky, advisor at Highclere Financial, said: “If you don’t put a life cover in trust, most insurers will wait until they hand out wills or letters of administration for those who die intestate – intestate.
The value of the insurance payments is then added to the value of the estate and can be subject to inheritance tax of 40 percent while if no will is written, the money can go to someone the insured never intended.
If you have an existing unsecured life policy, it’s a fairly straightforward process to transfer.
Lucky said: ‘This can be achieved fairly easily but care must be taken if the guaranteed life is in poor health.
“This could be considered by the tax collectors to be a disposition beyond the annual inheritance tax exemption and the benefits would be taxable.”
Jonny Timpson of Scottish Widows said: “Professional advice should always be sought on the type of confidence you need to achieve your goals.
Life companies usually have a number of draft formulations available outside of the tie-down system which can be suitable for personal or commercial purposes but in other cases legal advice should be sought.
“Every trust works a little differently and it’s important to choose the right trust for you, hence the need for advice.”
Different types of trust
Plain and simple confidence that does exactly what you want it to do
Trusts can take the pain out of managing a person’s possessions after they are gone
This is the simplest form of trust. In fact, it is sometimes called abstract, explicit, or absolute confidence.
Once written, an abstract trust cannot be changed.
The settlor (the person who creates the trust and places the property, wealth, or insurance policies in it) decides who the beneficiaries are and what they want each to receive.
From then on, the property in the trust and any profits generated therefrom belong to the listed beneficiaries of the trust.
Since the beneficiaries and their benefits are taxed in bare trust, no future beneficiaries can be added even if the settlor has more children or grandchildren.
Once the life insurance plan is in a bare trust, the settlor cannot benefit from it. So a mere trust is not appropriate for a policy that includes any coverage that would pay interest to the settlor if a claim was made while they were still alive. For example, a plan that includes critical illness coverage is not suitable for naked trust.
With an abstract trust, trustees cannot make any beneficiary over the age of 18 wait before he or she acquires property held by the trust for them. This can be a concern if the beneficiaries are young and the trustees believe they should wait before they take ownership of the trust.
A direct trust where you want the appointed trustees to have the ability to make discretionary decisions on your behalf
A discretionary trust is based on the discretion of the trustees who are appointed by the settlor to administer the trust. In a naked trust, assets must be distributed to beneficiaries over the age of 18 if they request it but with a discretionary trust, trustees can hold assets until they think it is the right time to distribute them.
Trustees can choose who will benefit and how much they will receive which means they may ‘bypass’ some of those listed as ‘potential beneficiaries’.
It is therefore very important that you assist the trustees by indicating who you would like to benefit from your plan either by naming them in the potential beneficiaries section of the trust or by completing an Expression of Interest form which can be kept with the trust form.
The Expression of Wishes form is not a legally binding document but will help guide the trustees when the time comes to distribute the benefits of the policy to the beneficiaries.
Unlike a naked trust, new beneficiaries can be added to or removed from a trust. This can be useful, for example, if the settlor has another child or grandchild or if they fall out with someone they previously wanted to profit from the trust.
One of the risks of a discretionary trust is that the trustees have significant influence over the trust, its assets, and its distribution. So choosing the wrong trustees can lead to complications in the future. For example, they can refuse to allow the settlor to add another beneficiary or to appoint another trustee. They can also refuse to give some of the trust’s assets to a beneficiary, even though you would have wanted them to receive it.
A discretionary trust also includes the trustees’ authority to make loans to individuals who may be beneficiaries of the trust.
Split trust if you want to access the policy proceeds if you are diagnosed with a terminal or critical illness
A split trust allows you, as a settler, to split your policy so that you keep some of the benefits and some are put into the trust. With a divided trust, life insurance benefits must be paid into the trust but the settlor can choose to retain other benefits, including the terminal illness component of his life coverage.
Other benefits withheld are things like critical illness coverage, the type of coverages designed to help protect the settlor’s lifestyle and/or income replacement, help paying for care, modifications you may need to make to your home and so on.
Beneficiaries can be added and trustees appointed or removed but only with the consent of the trustees. As with a discretionary trust, one danger of a trust being broken is the power the trustees have. Again, this is one of the reasons why it is important to choose the right trustees.
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