How to Put Your Life Insurance Policy in Trust (And Avoid 40% Tax)

A step-by-step guide to writing your policy into Trust, ensuring your payout goes to your family instantly and bypasses Inheritance Tax

Arranging life insurance is one of the most responsible financial steps you can take for your family. It provides a vital safety net, ensuring your loved ones are protected should the worst happen. Yet, a staggering number of policyholders in the UK make one critical oversight: they fail to place their policy in Trust.

This simple, free, and straightforward step can be the difference between your family receiving a tax-free payout within days, or losing up to 40% of it to Inheritance Tax and waiting months, or even years, for the funds to clear probate.

At WeCovr, we believe that effective protection planning goes beyond just finding the right policy. It's about ensuring the structure is perfect, so the money gets to the right hands at the right time, with maximum efficiency. This definitive guide will walk you through everything you need to know about using a Trust to safeguard your life insurance payout.

What is a Life Insurance Trust?

Think of a Trust as a secure legal wrapper that you place around your life insurance policy. When you do this, you legally separate the policy from your personal assets, known as your 'estate'.

A Trust has three key roles:

1. The Settlor (or Grantor): This is you, the person who sets up the Trust and places the life insurance policy into it.
2. The Trustees: These are the people you appoint to manage the Trust. You will typically need at least two. Their job is to make a claim on the policy when you pass away and then distribute the money to your chosen beneficiaries according to your instructions.
3. The Beneficiaries: These are the people (or person) you want to receive the money from the policy payout. This could be your spouse, children, grandchildren, or anyone else you choose.

By placing your policy in a Trust, you are no longer the legal owner of it. The Trust owns it. This small legal distinction has enormous financial consequences for your loved ones. The payout from the policy is paid directly to the Trustees for the benefit of your beneficiaries, completely bypassing your estate.

Why Put Your Life Insurance in Trust? The 4 Core Benefits

Using a Trust isn't an obscure legal trick for the super-wealthy. It's a standard, highly effective planning tool recommended for the vast majority of personal and business life insurance policies. Here are the four crucial reasons why.

1. Avoid 40% Inheritance Tax (IHT)

This is the single biggest financial reason to use a Trust.

• How IHT Works: In the UK, if your total estate (including property, savings, investments, and life insurance not in Trust) is worth more than the 'Nil-Rate Band' when you die, the excess is typically taxed at 40%.
• The Thresholds (2025/2026):
  • The standard Nil-Rate Band (NRB) is £325,000.
  • The Residence Nil-Rate Band (RNRB) adds an extra £175,000 if you pass your main home to direct descendants.
  • Spouses and civil partners can transfer their unused allowances, potentially giving a surviving partner a total threshold of up to £1 million (£325k + £175k, doubled).

A substantial life insurance payout can easily push a seemingly modest estate over these thresholds.

Real-Life Scenario: The IHT Trap

David is a widower with an estate worth £400,000. He takes out a £250,000 life insurance policy to leave a legacy for his two adult children. He doesn't place the policy in Trust.

When David passes away, the £250,000 payout is added to his estate.

• Total Estate Value: £400,000 + £250,000 = £650,000
• IHT Nil-Rate Band: £325,000
• Taxable Amount: £650,000 - £325,000 = £325,000
• Inheritance Tax Bill: 40% of £325,000 = £130,000

David's children receive only £120,000 from the policy after tax. If he had placed the policy in Trust, the full £250,000 would have gone to them, tax-free. The Trust would have saved his family £130,000.

2. Bypass Probate for an Instant Payout

When you die, your executor must apply for a legal document called a Grant of Probate (or Confirmation in Scotland) before they can access your assets and distribute them.

• The Problem: The probate process is notoriously slow. It can take anywhere from 6 to 12 months, and in complex cases, it can drag on for years.
• The Impact: During this time, your life insurance payout is frozen along with the rest of your estate. Your family cannot access the funds needed to pay for funeral costs, clear a mortgage, or cover daily living expenses.

A Trust completely solves this problem. Because the policy is owned by the Trust, not your estate, the Trustees do not need to wait for probate. Once they have the death certificate, they can claim the funds from the insurer and distribute them to the beneficiaries, often within a few weeks. This provides immediate financial relief when it's needed most.

3. Control Who Benefits and When

A Trust gives you precise control over your legacy. The Trust Deed is a legal document outlining your wishes. This is invaluable in many situations:

• Protecting Young Beneficiaries: You can instruct Trustees to hold the money until your children reach a more mature age (e.g., 21 or 25), preventing a large sum from being squandered.
• Complex Family Structures: In cases of blended families or second marriages, a Trust ensures the money is distributed fairly according to your exact wishes, avoiding potential family disputes.
• Vulnerable Beneficiaries: If a beneficiary has a disability, is in receipt of means-tested benefits, or has issues with addiction, a Trust allows Trustees to manage the funds on their behalf, providing financial support without disrupting state benefits or handing over a lump sum.

4. Protection From Financial Risks

Once the policy is in a Trust, the payout is legally designated for the beneficiaries. This can offer a layer of protection if a beneficiary were to face financial difficulty, divorce, or bankruptcy in the future, as the funds held within the Trust are generally shielded from their creditors.

A Simple Comparison: Trust vs. No Trust

The Step-by-Step Guide: How to Put Your Policy in Trust

Contrary to popular belief, setting up a Trust for your life insurance is a simple administrative task, not a complex legal saga. Most insurers provide the necessary forms and guidance for free when you take out a policy.

Here is the process from start to finish.

Step 1: Choose Your Life Insurance Policy

You can't have a Trust without a policy. The first step is to determine your needs and find the right cover. Whether it's Term Life Insurance to cover a mortgage, Family Income Benefit to provide a regular income, or a Whole of Life plan for IHT planning, our expert advisers at WeCovr can help you compare the entire UK market to find the best policy at the most competitive price.

Step 2: Choose Your Trust Type

Insurers offer several standard Trust types. The two most common are Absolute and Discretionary Trusts.

Absolute (or Bare) Trust

• What it is: The simplest form of Trust. The beneficiaries are named, fixed, and cannot be changed once the Trust is created.
• How it works: Each named beneficiary has an immediate and absolute right to their specified share of the policy payout.
• Who it's for: People with very simple and unchanging family circumstances. For example, leaving everything to a spouse, or splitting it equally between your two children.
• Downside: It's completely inflexible. If you divorce, have more children, or fall out with a beneficiary, you cannot alter the Trust.

Discretionary Trust

• What it is: The most flexible and commonly used type of Trust. You don't name specific beneficiaries, but rather a class of potential beneficiaries (e.g., "my spouse, my children, and my grandchildren").
• How it works: The Trustees have the 'discretion' to decide which beneficiaries from this class receive money, how much they get, and when they get it. You guide them with a private 'Letter of Wishes'.
• Who it's for: The vast majority of people. It's ideal for those with young families, complex family structures, or who want to allow for future changes (like new children or grandchildren).
• Downside: You must have complete faith in your Trustees to follow your wishes.

Comparison of Trust Types

Step 3: Appoint Your Trustees

Your Trustees are the legal guardians of the policy. Choosing them is a critical decision.

• Who can be a Trustee? You can appoint family members, trusted friends, or a professional like a solicitor or accountant. They must be over 18 and of sound mind.
• How many? You must have at least two, but it's wise to appoint three or four in case one is unable to act when the time comes.
• Key Qualities: Choose people who are responsible, trustworthy, financially sensible, and ideally younger than you. The person who is your Will's executor is often a good choice.

You cannot be a Trustee of your own Trust, as you are the Settlor.

Step 4: Name Your Beneficiaries

• For an Absolute Trust, you will list the full names of the beneficiaries and the percentage share each will receive.
• For a Discretionary Trust, you will define the group of potential beneficiaries. For example, "My wife, Jane Doe, my children, and any future grandchildren."

Step 5: Complete and Submit the Trust Form

Your insurer will provide you with a Trust Deed form, often alongside your policy application. It's typically a 'fill-in-the-blanks' document.

You will need to fill in:

• Your details (the Settlor).
• The policy number.
• The names and addresses of your Trustees.
• The details of your Beneficiaries (or class of beneficiaries).

This service is provided free of charge by insurers and brokers like WeCovr. For most people, a solicitor is not required.

Step 6: Sign and Witness the Deed

The final step is to sign the Trust Deed in the presence of an independent witness (someone who is not a Trustee or beneficiary). Your Trustees will also need to sign the form to accept their role. Once signed and sent back to the insurer, your policy is officially in Trust.

Trusts and Different Protection Policies: A Closer Look

Trusts work seamlessly with most life insurance products, but there are some nuances to understand.

Term Life Insurance & Family Income Benefit

These are the most common policies to be placed in Trust. As they are designed to provide for dependents upon death, a Trust is the perfect vehicle to ensure the payout is fast and tax-free. Family Income Benefit, which pays a regular income rather than a lump sum, can also be placed in trust, with the Trustees managing the income stream for the beneficiaries.

Whole of Life Insurance

This is a policy that guarantees to pay out whenever you die. It's a cornerstone of Inheritance Tax planning.

• Modern 'Pure Protection' Whole of Life: As the prompt highlights, the vast majority of Whole of Life policies sold in the UK today are pure protection plans. They have no cash-in value or investment component. You pay a premium, and in return, the policy guarantees a fixed lump sum on death. If you stop paying premiums, the cover ceases and you get nothing back. These simple, transparent policies are ideal for placing in a Discretionary Trust to provide a tax-free sum to cover a future IHT bill or leave a guaranteed legacy. At WeCovr, we specialise in comparing these effective protection-focused plans.
• Older 'With-Profits' Policies: Older types of Whole of Life plans did have an investment element. They were complex, expensive, and their value depended on investment performance. These are rarely sold today in the protection market.

Critical Illness Cover

This is more complex. Critical Illness Cover pays out if you are diagnosed with a specified serious illness. As you need the money yourself to cover lost income or medical costs, you wouldn't typically place a standalone policy in a standard Trust.

However, for joint life and critical illness policies, special 'Split Trusts' are available. These are designed so that any critical illness payment comes to the policyholder, but the life insurance element remains within the Trust for the beneficiaries upon death.

Income Protection & Personal Sick Pay

These policies should not be placed in Trust. Income Protection is designed to replace your lost earnings if you are unable to work due to illness or injury. The benefit is paid directly to you while you are alive to cover your own bills. Placing it in Trust would prevent you from accessing the money.

Essential Trust Planning for Business Owners & Directors

For business owners, Trusts are not just good practice; they are fundamental to ensuring business survival.

Key Person Insurance

If a business would suffer financially from the death of a crucial employee (including a director), it can take out Key Person Insurance on their life.

• How it Works: The business pays the premiums, and the policy pays out a lump sum on the key person's death.
• The Role of the Trust: The policy should be written into a Business Trust. This ensures the payout goes directly to the business, not into the deceased's personal estate where it would be taxed and delayed by probate. The funds can then be used immediately to clear debts, recruit a replacement, or manage the disruption.

Shareholder or Partnership Protection

This ensures a smooth transition of ownership if a shareholder or partner dies.

• How it Works: Each shareholder takes out a life policy on the other shareholders, often written in Trust. This is combined with a legal 'cross-option agreement'.
• The Role of the Trust: On death, the Trust provides the surviving shareholders with the immediate, tax-free cash to buy the deceased's shares from their estate. This is vital for business continuity, preventing the shares from passing to family members who may have no interest or expertise in running the company.

Relevant Life Policies

A Relevant Life Plan is a highly tax-efficient death-in-service benefit for individual employees or directors of small companies.

• How it Works: The company pays for the life insurance policy. It's an allowable business expense and is not treated as a P11D benefit for the employee.
• The Role of the Trust: By law, a Relevant Life Policy must be written into a Discretionary Trust from the outset. This ensures the payout goes directly to the employee's family, bypassing both the business and the employee's personal estate for Inheritance Tax purposes.

5 Common Mistakes to Avoid When Setting Up a Trust

While the process is simple, there are pitfalls to be aware of.

1. Delaying It: The best time to put a policy in Trust is when you take it out. If you do it later, it could be considered a 'chargeable lifetime transfer' by HMRC and may have tax implications. Do it from day one.
2. Choosing the Wrong Trustees: Appointing someone who is disorganised, not financially astute, or likely to be influenced by others can undermine your plans. Choose wisely and have a backup.
3. Picking an Inflexible Trust: An Absolute Trust can cause major problems if your life circumstances change. For most people, a Discretionary Trust is the safer, more future-proof option.
4. Forgetting the 'Letter of Wishes': With a Discretionary Trust, you must write a Letter of Wishes. This is a separate, private document that guides your Trustees on how you'd like the money distributed. It's not legally binding, but it's essential for them to understand your intentions. You should review and update it after major life events.
5. Assuming it's Complicated or Expensive: The biggest mistake is not doing it at all because of a misconception that it's difficult or costly. For 99% of policies, it is a simple, free process included by your insurer.

Start Your Protection Journey Today

Putting your life insurance in Trust is arguably as important as having the policy itself. It's a simple, no-cost action that secures your entire investment, protects your family from a 40% tax bill, and provides them with immediate financial support.

At WeCovr, our expert advisers don't just find you a policy; we ensure it's structured perfectly to meet your goals. We guide you through the Trust process step-by-step, helping you compare plans from all major UK insurers to secure the right protection for your family or business.

As part of our commitment to our clients' long-term wellbeing, every WeCovr customer also receives complimentary access to CalorieHero, our AI-powered nutrition and fitness app, helping you build healthier habits for a longer, happier life.

Don't leave your family's future to chance. Take the crucial step today to ensure your legacy is fully protected.