Life Insurance and Inheritance Tax: Why Writing Your Policy 'In Trust' Matters

A life insurance payout is meant to support your family when they need it most - but without a simple, free step taken when the policy is set up, a meaningful chunk of it can be swallowed by Inheritance Tax and delayed by the probate process.

Why a life insurance payout can be caught by IHT

By default, a life insurance payout on your death is paid to your estate, and counts as part of its value for Inheritance Tax purposes - just like any other asset. If your estate is already close to or over your available nil-rate bands, the payout can push more of your estate above the threshold, taxed at 40%, precisely at the moment your family most needs the money in full. If everything passes to your spouse or civil partner there’s normally no Inheritance Tax to pay anyway - so the IHT benefit of a trust matters most for unmarried couples, and when the second partner dies.

How writing a policy ‘in trust’ solves this

Writing a life insurance policy in trust means the payout goes to the trustees, who pass it on to your chosen beneficiaries (typically your spouse, children, or whoever you choose), rather than into your estate - this means it’s generally outside your estate for Inheritance Tax purposes and doesn’t get taxed as part of your estate. Most insurers’ trust forms are discretionary trusts, which can face small periodic or exit charges if money is left in the trust for many years - trustees who pay the money out promptly will usually avoid these. The premiums you pay into a policy held in trust technically count as gifts, but are normally covered by the £3,000 annual exemption or the exemption for regular gifts out of income.

The second major benefit: speed

Because a payout to a trust doesn’t need to wait for Grant of Probate (which can take months), trustees can typically access and distribute the funds considerably faster than money passing through the estate - at exactly the point families may most need quick access to funds for immediate costs like funeral expenses or ongoing living costs. It’s a similar principle to how a jointly-owned property held as joint tenants passes straight to the surviving owner without needing a Grant of Probate at all (see our dedicated article on joint tenants vs tenants in common).

Why this is usually free and simple to set up

Most insurers provide a straightforward trust form (commonly a ‘discretionary trust’ or ‘flexible trust’) as part of arranging the policy, at no additional cost - it’s a simple form to complete alongside the policy application, naming your chosen trustees and beneficiaries, rather than a separate legal process requiring a solicitor in most straightforward cases.

Why so many people don’t do this

Writing a policy in trust is frequently overlooked, either because it’s not proactively offered or explained clearly at the point of taking out the policy, or because it seems like an unnecessary extra step for something that feels straightforward. This is a genuinely common and avoidable gap - checking whether an existing life insurance policy is written in trust, and arranging this if not, is one of the simpler pieces of estate planning available.

What if you already have a policy not written in trust?

Most insurers allow you to write an existing policy into trust after the fact, not just at the point of taking it out - worth checking with your specific provider if you have life insurance and aren’t sure whether this step was taken originally. For most term policies this has no tax consequences, but if the policy has a cash-in value or you’re in serious ill health, get advice first, as the transfer can count as a gift for Inheritance Tax.

Choosing trustees and beneficiaries

• Trustees manage the trust and ensure the payout reaches the intended beneficiaries - you’ll usually be a trustee yourself, alongside at least one other person, commonly a spouse and/or adult children, though this should be someone you trust to act in the beneficiaries’ interests.
• Beneficiaries are who the payout is ultimately intended for - you can specify individuals directly, or use a more flexible ‘discretionary’ structure giving trustees some latitude over final distribution among a named group.
• Keep the nominated trustees and beneficiaries updated as circumstances change - a divorce, remarriage, or new children are all reasons to review who’s named on an existing policy’s trust arrangement.

A note on mortgage life insurance specifically

If your life insurance is specifically intended to pay off a mortgage on your death, writing it in trust with your intended beneficiaries (rather than automatically to a lender) still generally makes sense for the same IHT and speed reasons, as long as the policy hasn’t been assigned to your lender - some lenders require this, which can prevent it being written in trust, so check first - though you’ll want the trust structured so the money reaches whoever you intend to actually use it to manage the mortgage or property situation.

The bottom line

Writing a life insurance policy in trust is a simple, usually free step that keeps the payout outside your estate for Inheritance Tax purposes and lets your family access it considerably faster than waiting for probate. Check whether your existing policy has this in place, and if not, most insurers can arrange it retrospectively at no extra cost - just get advice first if the policy has a cash-in value or your health has changed.