Writing Policies in Trust FAQ
Following feedback from our recent Specialist Lending Training Academy, we’ve created a helpful FAQ guide which covers the key things you need to know when writing policies in trust.
Why put a policy in trust?
A policy validly placed in trust may:
- mitigate the effects of inheritance tax*
- may assist the life insurance company to pay out faster. A policy in trust is designed to allow payment of the policy proceeds to the chosen trustees without the need for a grant of probate/ letters of administration/ confirmation, thereby potentially helping to avoid probate delay in the event of a claim
- prevent the creditors claiming against the policy
- allow the client to stipulate who their money will be paid to on death as opposed to their estate as a whole. E.g. if the client has remarried then their estate would go to their wife but you could write a life policy in trust for the children, or even the wife from the first marriage.
*As of April 2017, inheritance tax is charged at 40% of the value of an estate over £325,000 (or 36% if the client leaves 10% or more of your net estate to charity).
What risks should Advisers and clients be aware of?
- Once a policy is put in trust, it is the trustees who will administer the policy proceeds and make the decisions regarding distributing the monies to the relevant beneficiaries. If a client places a policy under trust, they might be giving up all of their rights to the proceeds and they may not have any control over the decisions that they make after their death.
- If they are a trustee of a policy, then they may still have to share control with any other trustees.
- If they choose to set up a policy in the form of a “discretionary trust”, the trustees will have a wide discretion to choose which of the beneficiaries are to receive any funds from the policy in the event of a claim being paid. The client may prepare a letter of wishes to guide the trustees as to which of the discretionary beneficiaries they would like to receive benefits, and in what way, but they cannot limit the trustees’ discretion or bind them.
What are the key roles in a trust?
There are three key roles in a trust:
- The settlor (or settlors) – The person giving away their life insurance policy is called the settlor, and if you have a joint policy then both policy holders are automatically joint settlors. Once the settlor has put their policy into trust, they no longer personally own it, as it’s owned by the trust, so they have limited rights to say how it’s dealt with. However, the settlor is still responsible for paying the insurance policy premiums and is also usually a trustee, so they do retain some influence on how the trust is managed as a trustee. The settlor chooses the trustees and the beneficiaries and completes the trust form to set up a trust.
- The trustees – The trustees are the people you choose to look after the trust, make any future claims, and arrange for the money to be paid to your beneficiaries in line with your instructions. As the settlor, you are automatically a trustee. Once the policy is put in trust, the trustees take legal ownership of the trust fund from you and must then act in the best interests of all the beneficiaries at all times, and can only do what is allowed in the trust deed.
- The beneficiaries – These are the people (or person) who you want to receive the money from the trust fund.
What clients can set up a trust?
Most life policies can be put into trust, so anyone who owns a policy can set one up.
What happens if a trust is not set up?
If a policy is not placed in trust, the policy proceeds may not go to the people who the client wants to receive it.
Without a trust, for a joint policy, the policy proceeds will automatically be paid to the survivor.
However, for a single life policy not placed in trust, there could be a delay before a spouse or partner receives the policy money. This is because when someone dies, if the policy is not in trust the client’s personal representatives will need to obtain probate so that they have the authority to deal with their estate. The policy money will then be distributed in accordance with the will, or the laws of intestacy if the client has not made a will.
The worst case could be if the client is not married, and has not made a will, then the partner may not be legally entitled to the policy proceeds at all unless placed in trust.
What is a Letter of Wishes?
The client can give trustees a letter telling them how they would like the money shared out, which is called a Letter of Wishes.
Types of Trusts
There are four main types of trusts; Absolute, Discretionary, Survivor’s Discretionary and Flexible Trusts.
The types of people who may benefit are listed in the trust deed and include the client’s spouse, children and other family members. Other potential beneficiaries can also be added.
However, none of the beneficiaries can be sure they will benefit from the trust as it is the trustees who choose which potential beneficiaries will receive any money, how much and when.
It is called a Discretionary Trust because the trustees have a lot of discretion about who to pay. As such a simple letter from the client stating what they would like to happen to the money, which is called a Letter of Wishes, is often a helpful way to give the trustees guidance. This letter to the trustees can be rewritten at any time but should always be sent directly to the trustees.
Survivor’s Discretionary Trust
A survivor’s discretionary trust is similar to a standard discretionary trust, however it’s only suitable for joint life policies, where the insurance money is paid after the first person dies. It is different from a standard discretionary trust because, in a survivor’s discretionary trust, if one of the original policy owners (settlors) dies but the other settlor survives, the survivor will be entitled to the money from the policy. If both settlors die within 30 days, then the discretionary beneficiaries will benefit in the same way that they would for a standard discretionary trust.
An absolute trust is the least flexible of the four trusts. The beneficiaries are named individuals who cannot be changed in the future. For example, children born later cannot be included or a spouse cannot be removed following a divorce. The beneficiaries are absolutely entitled to the trust fund, and the trustees do not have discretion on who to pay.
A flexible trust is similar to a discretionary trust, but it is more complicated. There are two types of beneficiaries. The first type of beneficiary is the default beneficiary. These beneficiaries are people who are entitled to any income from the trust as it arises. In practice, if the life policy is the only asset in the trust there will not usually be any income until after the claim is made. The second type of beneficiary is the discretionary beneficiary. These discretionary beneficiaries are people who your trustees can decide to give money to at their discretion. They only receive capital or income from the trust if the trustees make appointments to them during the trust period. If no appointments are made by the end of the trust period, the default beneficiaries will receive all of the benefits.
How many trustees should you have?
It is suggested that a maximum of four and minimum of three trustees are chosen, however, it’s up to the client to decide how many trustees they want. The client is automatically a trustee, and so is any other person named on the policy if the life insurance is a joint policy. You must appoint at least one other trustee, but you can choose more than that.
Your trustees need to be over 18, and it’s usually easier if they’re UK taxpayers who live in the UK. If you want non-UK trustees, you might want to consider taking specialist legal and tax advice on this.
Can you change the trustees on the policy?
Yes, trustees can change for a number of reasons. A trustee may want to retire, and they can do this if all the trustees agree. To change a trustee, all the trustees must agree including the trustee being changed.
If a trustee dies, the remaining trustees can still carry on but a replacement may be needed.
The trustees take legal ownership of the trust fund. Where a protection insurance policy is the only thing in the trust, they will usually not have much to do until the time comes to make a claim. When making trust decisions they must agree with all of the other trustees and must act in the best interests of the beneficiaries. Trustees are not allowed to profit personally from their role as trustee.
If you would like any further support or materials to help you when explaining the policy to your clients, then please do not hesitate to contact our internal Protection Specialist, Claire Doyle, on 01702 538 800 or email firstname.lastname@example.org.
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