The question of whether a protection policy should be written in trust is one that every adviser should ask themselves (and their clients) for every case.
This article also touches on the age-old question of whether two single life policies provide a better solution than a joint life policy.
Phil Day- Business Development Manager - Sourcing
5 min read
Assessing a client's needs and articulating this to them, getting their agreement to proceed and subsequently getting the acceptance of the insurer through underwriting is no mean feat but is that the end of the journey?
The answer is no.
The end of the journey is when or if a claim is paid and ensuring the money reaches the right people, quickly and tax efficiently.
Let’s look at this in more detail and some of the potential pitfalls of not having these conversations with your client.
Firstly, what are the benefits of a trust?
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Writing policies under trust ensures that payments can be made to beneficiaries quickly. In the case of life cover, probate will not be required and the trustees will be able to distribute the money in line with the policyholder’s wishes and avoid probate fees.
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In the budget of November 2022, the government announced the freezing of the Nil Rate Band and Residence Nil Rate Band until 2027-2028. Inheritance tax is payable at 40% on any part of an estate valued over this amount. However, you can use a trust to ‘gift’ some or all of the benefits of a life policy to other people. These benefits would no longer be part of your client's estate if they die and therefore would not be subject to inheritance tax.
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Existing personal policies not written in trust (excluding Relevant Life plans) can still be placed into a trust at any time. This is a fantastic way to review your client’s policies, price, value, suitability and check your clients understanding of their protection products - Sounds a bit like Consumer Duty?
So how does the end of the journey look for policies in trust?
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Lengthy delays caused by probate have been eliminated.
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The risk of the money ending up in the hands of someone you did not intend to has also been removed.
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It also has the added advantage of falling outside the estate so not exposed to IHT.
What do we mean by the money ending up in the wrong hands?
As an example, an unmarried couple have taken two single life policies: they have no children and no will in place. If one were to die, the rules of intestacy mean that any assets (for this example, the life policy) will pass firstly to the deceased’s parents. If the parents are no longer with us then the list continues with brothers, sisters, nieces, nephews, uncles, aunts etc etc.
No living relatives? Then the Crown is the beneficiary.
Rightly or wrongly, the partner is not on the list!
For unmarried couples, the best solution would be for each partner to take out individual protection cover and write them into trust with the beneficiary being the other partner. With a trust, beneficiaries can easily be changed should there be a need to do so. This can be accommodated in a Letter of Wishes.
Some providers allow clients to nominate a beneficiary as part of their application. As it is then part of the contract, the claim can be paid to the nominated beneficiary without having to wait for probate to be granted. This can be a viable alternative to using a trust and should be considered for clients where they require a straightforward payment of claim to a single or small number of beneficiaries. Currently I believe there are only two providers offering this but it is something I would like to see more widely available.
I’ve heard advisers say that using a joint policy would avoid such issues. However, what other issues could this create? Whilst the proceeds of a joint life policy will be paid in the event of a claim to the surviving policyholder and will be paid promptly, for an unmarried couple, half of the value of the joint life policy will be included in the estate of the deceased.
Although the survivor would have already claimed the full sum assured and although the funds from the life assurance policy will never actually enter the estate of the deceased, they could be taxed. It is quite conceivable that half of the sum assured being included in the estate of the deceased could increase or give rise to an inheritance tax charge.
Therefore, for unmarried couples, would it not make sense to write the policy in trust? Or consider individual policies also written in trust?
There is another situation we need to consider for joint policies. What would happen with the proceeds from the policy if both lives assured died at the same time?
We know that if the first life dies and the other survives, the survivor can claim the proceeds quickly. However, If they both die at the same time it’s deemed the eldest had died first and the youngest second. Therefore the claim is paid to the estate of the youngest and the life company will require a grant of probate on the second death as part of the claims process.
Even for a married couple with a joint policy, this can create problems. Whilst there’s unlikely to be any IHT concerns on first death for a married couple, on the second death the value of life policy is now part of their estate and would be exposed to IHT.
There are specific trusts for joint life first death life policies, which include a Survivorship clause with a 30-day rule. An example of the importance of this type of trust that I have seen first hand involved a couple who were in a traffic accident. Sadly, the husband died at the scene but his wife, although initially in a critical condition, survived. As she passed the 30 day rule she was entitled to receive the plan proceeds.
If she had not survived the 30 days following the death of her husband, the plan proceeds are held in trust for the trustees to make payment to the correct beneficiaries as per their wishes. The proceeds will not enter their estate and therefore not form part of any Inheritance Tax calculation. An awfully sad situation but no claim is anything but sad. However, the policy (and trust) did what it was intended to do.
The bottom line is that Consumer duty and “doing the right thing” requires a deeper conversation around trusts and beneficiaries.
The obligation on advisers to discuss this with their clients is both a professional and a moral one.
The views expressed in this article are purely those of the author and are not to be seen as financial advice
