Family Income Benefit Insurance UK Tax and Trusts

Family Income Benefit is a cornerstone of financial protection for countless UK families. It offers a reassuringly simple promise: if you pass away during the policy term, your loved ones will receive a regular, tax-free income, rather than a single lump sum. This can be a lifeline, helping to cover everything from the mortgage to the weekly food shop, ensuring your family's lifestyle is maintained during a difficult time.

However, simply having the policy isn't enough. To truly maximise its effectiveness and ensure the money reaches your family swiftly and without unnecessary tax complications, understanding how to use trusts is paramount. Many people overlook this crucial step, potentially exposing the payout to delays and even Inheritance Tax.

This comprehensive guide will demystify the process. We will explore what Family Income Benefit is, why trusts are so vital, and provide a step-by-step walkthrough on how to place your policy in a trust. We will also delve into the specific tax implications, ensuring you have the knowledge to protect your family's financial future with confidence.

How to set up FIB in a trust and understand potential tax implications

Setting up your Family Income Benefit (FIB) policy within a trust is one of the most powerful financial planning decisions you can make for your loved ones. At its core, the process involves legally assigning your policy to trusted individuals (trustees) who will manage the payout on behalf of your chosen beneficiaries.

The primary reasons for doing this are twofold: speed and tax efficiency.

1. Speed of Payout: When a life insurance policy is written in trust, the proceeds are paid directly to the trustees. This completely bypasses the lengthy and often stressful legal process of probate (the process of administering a deceased person's estate), which can take many months. For a family suddenly without a key earner, this rapid access to funds is invaluable.

2. Tax Efficiency: By placing the policy in a trust, it is legally separated from your estate. This means the payout is not typically considered for Inheritance Tax (IHT) purposes. With IHT currently at 40% on estates valued over the nil-rate band, this can save your beneficiaries a substantial amount of money.

The process is surprisingly straightforward, especially when done at the time you take out the policy. It usually involves completing a simple trust form provided by the insurer. In the following sections, we’ll break down this process in detail, explore the different types of trusts, and clarify the exact tax implications so you can make an informed decision.

What is Family Income Benefit? A Deep Dive

Family Income Benefit (FIB) is a specific type of term life insurance designed to provide a steady stream of income rather than a one-off lump sum payment upon the policyholder's death. Think of it as a replacement for your monthly salary for your family, ensuring they can manage their ongoing expenses without financial distress.

You choose the amount of income your family would receive and the length of the policy term. For example, you might take out a 20-year policy to provide £2,000 a month. If you were to pass away five years into the term, your family would receive £2,000 every month for the remaining 15 years. If you survive the term, the policy ends, and no payout is made.

This structure makes FIB particularly suitable for:

• Young families with children: The term can be set to last until your youngest child is financially independent.
• Single parents: It provides a crucial safety net to support children's upbringing.
• Anyone with dependents: It ensures ongoing financial commitments can be met without the burden of managing a large, intimidating lump sum.

The key advantage is affordability and simplicity for the beneficiaries. Because the total potential payout decreases over time, FIB premiums are often significantly lower than for a level term policy with a comparable lump sum value. For the family receiving the benefit, the regular payments make budgeting far easier than managing a large investment.

Family Income Benefit vs. Lump Sum Life Insurance

The Crucial Role of Trusts in Life Insurance

In the simplest terms, a trust is a legal arrangement that allows you to give an asset (in this case, your FIB policy) to a few people you trust (the 'trustees') to look after for the benefit of others (the 'beneficiaries').

When you take out a life insurance policy, you are creating a valuable asset that will pay out upon your death. Without a trust, this asset becomes part of your 'estate' – the total sum of all your property and money. Your estate must then go through probate before anything can be distributed to your heirs, and it may be subject to Inheritance Tax.

Using a trust neatly solves these two major problems.

1. Avoiding Probate for a Faster Payout

Probate is the legal process of validating a will and granting the executors the authority to distribute the deceased's estate. In the UK, this process is rarely quick. According to HM Courts & Tribunals Service data, the average time from submitting a probate application to a grant being issued can be several months, and complex estates can take much longer.

During this time, your family may be left in financial limbo, unable to access the funds you intended for them. An FIB policy written in trust bypasses probate entirely. Upon your death, the insurance provider can pay the proceeds directly to the trustees as soon as the claim is approved, often within a few weeks. This gives your family access to the income they need, when they need it most.

2. Mitigating Inheritance Tax (IHT)

Inheritance Tax is a tax on the estate of someone who has passed away. As of 2025, the standard IHT threshold (or 'nil-rate band') is £325,000. Anything above this value is typically taxed at a hefty 40%. While there are other allowances, such as the Residence Nil Rate Band for passing on a main home to direct descendants, a large life insurance payout can easily push an otherwise modest estate over the threshold.

Example without a Trust:

• Your estate (property, savings) is worth £300,000.
• Your life insurance policy pays out £250,000.
• Your total estate value is now £550,000.
• £225,000 of this (£550k - £325k) is potentially subject to IHT.
• The tax bill could be as high as £90,000 (40% of £225,000).

When you place your FIB policy in trust, you legally remove it from your estate. The payout goes directly to the beneficiaries via the trust, so it is not included in the IHT calculation on your death. This simple piece of administrative paperwork can save your family tens or even hundreds of thousands of pounds.

Step-by-Step Guide: How to Place Your Family Income Benefit Policy in Trust

Placing your FIB policy in trust is a straightforward process that your insurer and broker can help you with. It is almost always best to do this when you first take out the policy, as it's simpler and avoids potential complications later.

Step 1: Choose the Right Type of Trust

Insurers typically offer their own standard trust forms, which usually fall into one of two main categories. Choosing the right one depends on how much flexibility and control you want.

• Bare (or Absolute) Trust: This is the simplest form. You name the beneficiaries from the outset, and their shares are fixed. For example, "My two children, in equal shares". These beneficiaries cannot be changed once the trust is created. This provides certainty but lacks flexibility if your circumstances change (e.g., you have more children).

• Discretionary Trust: This is the most common and flexible option. You name a class of potential beneficiaries (e.g., "my spouse, my children, and my grandchildren") but you don't specify who gets what. You appoint trustees who have the 'discretion' to decide which beneficiaries receive payments, how much they get, and when. This allows them to adapt to the family's needs at the time of your death. It's also useful for complex family situations or if you have beneficiaries who may not be able to manage their finances responsibly.

Comparing Common Trust Types

Step 2: Complete the Trust Form

The insurer will provide a trust deed or form. This document will ask for the key details of the arrangement.

• The Settlor: This is you, the person creating the trust and placing the policy into it.
• The Trustees: The people you appoint to manage the trust.
• The Beneficiaries: The people you intend to benefit from the policy payout.
• The Trust Property: The insurance policy itself.

Step 3: Appoint Your Trustees

Choosing your trustees is a critical decision. They will have legal control over the policy payout, so you must choose people you trust implicitly to act in the best interests of your beneficiaries.

• They must be over 18 and of sound mind.
• You should appoint at least two trustees.
• You are automatically a trustee, so you'll need to choose at least one other person.
• Consider appointing a mix of family members (who understand your wishes) and perhaps a professional, like a solicitor (who understands the legal duties), especially for large or complex trusts.
• Always ask them first if they are willing to take on the role.

Step 4: Sign and Witness the Deed

Once the form is complete, it needs to be signed by you (the settlor) and your trustees. This must be witnessed by someone who is independent – meaning they are not a party to the trust (i.e., not a trustee or beneficiary). This formalises the legal arrangement. The completed form is then sent to the insurance company, who will endorse the policy to show it is subject to the trust.

At WeCovr, we guide our clients through this entire process as part of our service. We can help you understand the differences between the types of trusts and ensure the paperwork is completed correctly, giving you complete peace of mind that your policy is set up for maximum benefit.

Understanding the Tax Implications of Family Income Benefit

One of the most attractive features of Family Income Benefit is its favourable tax treatment, especially when combined with a trust. Let's break down how it's viewed by HMRC.

Income Tax

This is the simplest and most significant advantage. The regular income payments received by your beneficiaries from an FIB policy are not subject to Income Tax. Whether they receive £1,000 a month or £5,000 a month, it is paid to them completely tax-free. This makes it far simpler to calculate how much cover you need, as you don't have to account for any tax deductions.

Capital Gains Tax (CGT)

Capital Gains Tax is a tax on the profit when you sell or dispose of an asset that has increased in value. For standard life insurance policies like FIB, CGT is generally not an issue. The payout on death is not considered a 'chargeable gain'.

Inheritance Tax (IHT)

This is where using a trust becomes so important. The IHT treatment of your FIB policy depends entirely on whether or not it is written in trust.

• Policy NOT in Trust: If the policy is not in a trust, the insurance provider must pay the proceeds into your estate. HMRC requires the policy to be valued at the date of your death. For an FIB policy, this isn't the total of all future payments, but its 'open market value'. This is a complex calculation, but it creates a value that is added to your estate. This can be the crucial factor that tips your estate over the IHT threshold, leading to a 40% tax charge.

• Policy IN Trust: When the policy is written in trust, it is no longer legally part of your estate. The payout goes directly from the insurer to the trust. As a result, the payout is not included in the IHT calculation on your death. This simple step ensures the full benefit goes to your family as intended.

What about tax on the trust itself?

For discretionary trusts, there can be IHT charges in specific circumstances, known as 'periodic' and 'exit' charges. However, for a typical FIB policy held in a standard insurer's discretionary trust, these are rarely an issue. The trust's value is often considered nil until the policyholder dies. As the benefit is paid out as income rather than held as a large capital sum, the likelihood of triggering these charges is very low for most families.

Tax Treatment of an FIB Payout: A Summary

Family Income Benefit for Business Owners, Directors, and the Self-Employed

While FIB is often associated with traditional family structures, it is an exceptionally powerful tool for those who work for themselves or run their own companies. These individuals often lack the safety net of a corporate 'death in service' benefit, making personal protection essential.

Self-Employed and Freelancers

For a self-employed person, income can be variable and there's no employer to provide for their family if the worst should happen. FIB is a perfect fit.

• Cost-Effective Security: It provides a robust safety net at a more affordable premium than a large lump-sum policy.
• Simplicity: It directly replaces the lost monthly income that the family relies on, making the financial transition smoother.
• Peace of Mind: Knowing that the family's regular outgoings are covered allows a business owner or freelancer to focus on their work without that underlying financial anxiety.

Company Directors

Company directors have unique options available to them for tax-efficient protection. While FIB is a personal policy, it's important to understand it in the context of business-related protection.

• Relevant Life Cover: This is a type of death-in-service benefit for small businesses and directors. The company pays the premium, which is typically an allowable business expense, and it provides no P11D benefit-in-kind liability for the director. The payout is a lump sum, paid via a discretionary trust to the director's family. While not an income benefit, a director could take this out and advise their family to use the lump sum to generate an income. It can be a highly tax-efficient alternative to a personal policy.

• Executive Income Protection: This is different from FIB. It's a policy paid for by the business that provides a monthly income to the director if they are unable to work due to illness or injury. It protects the director during their lifetime, whereas FIB protects their family after their death. Both are vital components of a comprehensive protection plan.

• Key Person Insurance: This is insurance for the business, not the family. It provides a lump sum to the business if a key director or employee dies, helping to cover lost profits or the cost of recruiting a replacement. A director needs to ensure they have both personal protection (like FIB) for their family and key person protection for their business.

Navigating these different options can be complex. A specialist broker like WeCovr can provide expert advice on the most suitable and tax-efficient blend of personal and business protection for company directors and business owners.

Real-Life Scenarios: How FIB and Trusts Work in Practice

Theory is one thing, but seeing how these policies work in real situations truly highlights their value.

Scenario 1: The Young Family

• The Clients: Maya (34) and Ben (36) have two children, aged 4 and 6. They have a mortgage and rely on both their incomes.
• The Solution: They take out a joint life, first death FIB policy with a 21-year term to provide £2,500 per month. They want the policy to pay out when their youngest child is 25. They place the policy in a flexible discretionary trust, naming each other and their children as beneficiaries, with Maya's sister as an additional trustee.
• The Outcome: Tragically, Ben dies in a car accident eight years into the policy. Because the policy is in trust, the claim is approved quickly. Within weeks, the trust starts receiving £2,500 a month from the insurer. Maya, as a trustee, uses this tax-free income to cover the mortgage, childcare, and household bills. The process is fast, tax-free, and gives her financial stability during an impossibly difficult time.

Scenario 2: The Self-Employed Contractor

• The Client: David (42) is a self-employed IT contractor and the main earner for his family, including his partner and their teenage son.
• The Solution: David has no employee benefits. He takes out a single life FIB policy with a 15-year term to provide £3,000 per month. He places it in a discretionary trust, naming his partner and son as beneficiaries.
• The Outcome: If David were to pass away, the trust would provide a replacement for his contractor income. This ensures his partner can continue to pay the rent and bills and support their son through university without having to worry about managing a large, intimidating lump sum of money.

Scenario 3: The Estate Planning Couple

• The Clients: Helen (55) and George (58) have a significant estate including property and investments, valued at around £900,000. Their children are grown up but not yet fully established financially.
• The Problem: Any further assets added to their estate will be subject to 40% IHT. A lump sum life insurance policy would only add to this tax bill.
• The Solution: They take out a joint FIB policy with a 15-year term, providing a modest income of £1,500 per month. They place it in a discretionary trust for their children.
• The Outcome: When the first partner dies, the policy provides a supplementary, tax-free income to their children for the remainder of the term. Critically, because it's in a trust, the value of the policy payout does not enter their estate, saving their children from a potentially large IHT bill and providing financial support in a highly tax-efficient manner.

Beyond the Policy: WeCovr's Commitment to Your Health and Wellbeing

At WeCovr, we believe that financial protection is about more than just an insurance policy. It's about empowering you to live a long, healthy, and secure life. We understand that the foundation of financial security is good health, and we are committed to supporting our customers on their wellness journey.

This is why we go beyond simply arranging your insurance. As part of our commitment to your holistic wellbeing, every WeCovr customer gains complimentary access to CalorieHero, our exclusive AI-powered calorie and nutrition tracking application. This user-friendly tool helps you monitor your diet, make healthier food choices, and work towards your fitness goals. It’s a small way we can invest in your health, helping you live better today while being protected for tomorrow.

A healthy lifestyle can have a direct impact on your insurance. Insurers look favourably on applicants who are in good health, often rewarding them with lower premiums. By making small, positive changes to your diet, increasing your activity levels, and ensuring you get adequate sleep, you not only improve your quality of life but can also make your financial protection more affordable.

Choosing the Right Family Income Benefit Policy

When setting up your FIB policy, there are several key decisions to make to ensure it's perfectly tailored to your family's needs.

1. Term Length: How long do you need the cover to last? A common approach is to set the term to run until your youngest child is expected to be financially independent (e.g., age 21 or 25).
2. Cover Amount: How much income would your family need each month? A good starting point is to conduct a detailed budget of your essential monthly outgoings: mortgage/rent, utilities, food, transport, childcare, and any other regular costs.
3. Indexation (Increasing Cover): You can choose a 'level' benefit, which stays the same throughout the term, or an 'increasing' benefit. An increasing or index-linked policy sees the potential income rise each year, typically in line with inflation (CPI or RPI). This costs a little more, but it protects the real-terms value of the payout against the rising cost of living.
4. Joint Life vs. Two Single Policies: A joint life, first death policy covers two people but only pays out once, on the first death, after which the policy ends. Taking out two separate single life policies can sometimes be a better option. While it may cost slightly more, it provides double the cover, as each policy would pay out independently if each partner were to pass away during the term.

Finding the right policy involves balancing these factors to fit your budget. As an independent broker, WeCovr can compare plans from all the UK's leading insurers, including Aviva, Legal & General, Zurich, and Royal London. We do the shopping around for you, presenting the best options and providing the expert advice you need to make the right choice.

In conclusion, Family Income Benefit is a remarkably effective and affordable way to protect your family's financial security. It provides a straightforward replacement for lost income, ensuring that your loved ones can navigate a difficult future without immediate financial hardship.

However, its true power is only unlocked when it is correctly structured. By taking the simple, but crucial, step of placing your policy in a trust, you ensure the benefit is paid quickly, avoids the probate process, and is shielded from Inheritance Tax. This guarantees that the maximum benefit reaches your family when they need it most.

Navigating the world of trusts and protection insurance can seem daunting, but it doesn't have to be. Speaking to a protection specialist can provide clarity and confidence. Contact our friendly team at WeCovr today to discuss your circumstances, and let us help you build a secure financial future for your family.