Why up to 40% of your life insurance payout could end up in the hands of the tax man

by Mark Alexander

14:50 PM, 27th October 2010
About 8 years ago

Why up to 40% of your life insurance payout could end up in the hands of the tax man

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Why up to 40% of your life insurance payout could end up in the hands of the tax man

If your net assets are worth over £325,000 when you die, any money that you leave to anybody other than your husband, wife or civil partner will be taxed at 40%. This includes payouts from your life insurance policy, regardless of whether you’ve made a Will or not. The solution, which is very simple and cost effective, involves completing just one relatively simple document.

If your life insurance policies are not written into Trust there is a very good chance that you have this problem. Sadly, many life insurance policies sold by banks, building societies and estate agents were never written into Trust. You would know if they were because you would have had to appoint Trustees. It is possible to obtain Trust forms from your insurers; however, these are very generic and may not suit your requirements. Professional advice is always recommended. Do it yourself Trusts can be equally as dangerous as the DIY Will kits that are available online and through book shops.

Just imagine, you could be paying thousands of pounds in premiums for your insurance and actually leaving 40% of the benefits to the state. That’s a potential £40,000 windfall to the Tax Man for every £100,000 of life cover you have in place. Surely you would prefer this money to go to your loved ones?

The price of the advice you need is probably much lower than you would expect. To have a specialist Consultant visit you at your own home to provide the advice you need, take your instructions, draft the trust documentation and register the trusts with your insurer costs just £110. If you have multiple policies you will require multiple trusts but each subsequent trust costs only £45. If you purchase this service together with an Estate Planning package including mirror Wills and Lasting Powers of Attorney the fee is just £600 including up to two life insurance trusts and a discounted rate of just £35 for each subsequent life insurance trust.

As part of the insurance trust writing service we can also ask an Independent Financial Advisor to re-broke your insurances. More often than you might expect, the premiums can be reduced or improved cover can be offered for the same price.

Another benefit of re-broking your life cover is that you stand a very good chance of the insurance company putting you through a health check before they insure you. The insurance companies pay for these medicals. Booked privately they can cost hundreds of pounds so why not get one for free?

SCENARIOS

First the basics. If you own a life insurance policy and your estate claims on it the money goes to your estate. However, if you give the life insurance policy away whilst you are alive, by writing it into trust, it doesn’t. Inheritance tax (IHT) is only payable on the net value of your estate. If you don’t own the benefits of the life insurance you can’t be taxed on it. A life insurance trust does not pay tax on the proceeds of a life insurance payout. By writing a life insurance policy into trust you are effectively giving the benefits to the trust whilst you are alive.

Married couple, one dies, life insurance pays to partner, partner then dies later

Mr & Mrs Smith have a small property portfolio. Equity in this portfolio and their home amounts to £325,000. They also have £500,000 of life insurance. Mr Smith dies and life insurance pays out. Mrs Smith pays no Inheritance Tax as she was married to Mr Smith. Mrs Smith is now worth £825,000 net. Mrs Smith then dies and leaves everything to the children. The first £325,000 transfers to them tax free. The remaining £500,000 is taxed at 40% which equates to £200,000.

This £200,000 tax bill was avoidable. If the life insurance had been written into trust, neither Mr nor Mrs Smith would have owned the policy proceeds. So far as HMRC would be concerned, Mrs Smith would only have been worth £325,000 on her death. The proceeds of the life insurance policy would be managed by the trustees and Mr and Mrs Smith, along with their children would have been the beneficiaries. The trustees have something called a fiduciary duty only to use the money for the benefit of the trusts named beneficiaries. The family could have drawn money from the trust when they needed to spend it as opposed to having it all in their estate and increasing their IHT liability.

Married couple, one dies, life insurance pays to children, net assets were over £325,000

Mr & Mrs Jones have a small property portfolio. Equity in this portfolio and their home amounts to £325,000. They also have £300,000 of life insurance for the benefit of their three children. Mr Jones dies and life insurance pays out. In accordance with their Will, Mrs Jones retains the family home and the property portfolio and the children receive the benefits of the life insurance policy equally. Mrs Jones pays no Inheritance Tax as she was married to Mr Jones. However, the £325,000 nil rate band for IHT has been used. The £300,000 paid to the children is taxed at 40% which equates to each of the children getting a £40,000 Inheritance Tax bill to pay out of their £100,000 windfall.

The £120,000 Inheritance Tax bill was avoidable. If the life insurance had been written into trust, neither Mr nor Mrs Jones would have owned the policy proceeds. The proceeds of the life insurance policy would be paid to and managed by the trustees and their children would have been the beneficiaries. The children could have drawn money from the trust when they needed to spend it as opposed to having it all in their estate and increasing their IHT liability.

Unmarried person dies, assets excluding life policies are £325,000 or more

Mr Brown and Ms Taylor lived together as a couple for 20 years but never got around to getting married. Between them they jointly owned a property portfolio and their own home which had £650,000 of equity, dived equally. They also owned a life insurance policy worth £1 million. Mr Brown died and the life insurance policy paid out. In accordance with his Will the policy proceeds were paid to Ms Taylor. This instantly created a £400,000 Inheritance Tax bill for Ms Taylor.

This £400,000 tax bill was avoidable. If the life insurance had been written into trust, neither Mr Brown nor Ms Taylor would have owned the policy proceeds. So far as HMRC would be concerned, Ms Taylor would only have inherited £325,000 on her death which is below the IHT nil rate band. The proceeds of the life insurance policy would be managed by the trustees. The trustees have something called a fiduciary duty only to use the money for the benefit of the trusts named beneficiaries. Ms Taylor could have drawn money from the trust when she needed to spend it.

Single person dies, assets excluding life policies are £325,000 or more

Mr Bloggs is unmarried and has no children. Equity in his portfolio and his home amounts to £325,000. He also has £500,000 of life insurance to repay his mortgages on his death. Mr Bloggs dies and life insurance pays out. His Will states that his brother and his best friend will share the value of the estate. As Mr Bloggs estate is now worth £825,000 on death, this will produce a £200,000 Inheritance Tax bill for his beneficiaries.

This £200,000 tax bill is avoidable. If the life insurance had been written into trust, neither Mr Bloggs would have owned the policy proceeds. So far as HMRC would be concerned, Mr Bloggs brother and best friend would only have inherited £325,000 on his death which is below the IHT nil rate band. The proceeds of the life insurance policy would be managed by the trustees. The trustees have something called a fiduciary duty only to use the money for the benefit of the trusts named beneficiaries. Mr Bloggs brother and his best friend could have drawn money from the trust when they needed to spend it.

Who should I appoint as my Trustees?

You need to appoint people you trust. They have a fiduciary duty only to allow your named beneficiaries to benefit from the trust. If they allow the money to be diverted elsewhere they will be treated as criminals. Nevertheless, this does happen which is why you should choose somebody you really can trust. Usually this will be a best friend, spouse or family member. It is also advisable to have one professional trustee to countersign any cheques to be completely safe. Be careful though! Professional trustees can charge fees so make sure that their fees are clearly understood and are capped.

Update 16th May 2013



Comments

11:41 AM, 19th September 2012
About 6 years ago

Very good advice Mark. Something I used to talk about a lot with my clients. It really can make a huge difference. I remember one such lady, I saved her around £80k using this method.


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