Is it time to make your financial legacy tax proof?

by | Friday 1st May 2020 | Mortgage Insights

If you’re a homeowner, then chances are you’ll already have a life insurance policy in place to cover your mortgage, either because you decided it was the smart thing to do (which it is), or because your mortgage lender insisted on it. If you don’t currently have a life policy but you have significant outstanding debt on your mortgage loan, it would be prudent to consider taking out a policy to ensure that should you die the people you leave behind are able to meet that financial commitment. But the key question today, if you do already have a policy, is whether or not your policy was set up in a discretionary trust. Current Inheritance Tax (IHT) rules mean that if the estate you leave behind amounts to a value of more than £325,000, anything above that figure will be taxed at a rate of 40%.

Your estate comprises all of your property and financial assets, including any insurance policies you may have that payout on death. In many cases, it is these policies that tip someone’s estate beyond the £325,000 tax-free threshold.

There are circumstances in which this threshold can be extended – for example, when the estate is passing to a spouse or civil partner. But in most other cases, that figure of £325,000 is likely to trigger the tax liability on your legacy.

By writing your life insurance policy into trust, it can be excluded from your estate for probate purposes, meaning your loved ones will benefit from the full value of the policy when it pays out.

And because it is not considered as part of the probate process which, depending on the complexity of your estate, can take weeks or months to complete, the people you leave behind should receive that money more quickly.

It is rarely the case that your insurance company will pay out on your policy quickly. Their own claim processing times can also be long and drawn out and that can mean delays for your family at what is already likely to be a very distressing and expensive time.

Having your policy written into a discretionary trust circumvents that problem as well.

How discretionary trusts work (tax)

To write a life insurance policy in trust requires you (known as the settlor) to set up the trust, specify formally who you want to receive the proceeds of the trust and on what terms – which, for the purposes of this example, we’ll assume is upon your death – and appoint trustees who will administer the trust fund when the time comes.

Your beneficiaries will all fall into defined classes and this is to ensure your nominated trustees are able to properly identify who should receive all or part of the gift, as determined in your instructions.

Your beneficiaries can be anyone of your choosing, but they must be able to be identified in one of the several classes that will apply to the trust.

For example, you may specify ‘my grandchildren’ or ‘my nieces’, but you would not be able to specify something very general like ‘all my friends’ because the trustees would have no way of knowing how you defined a friend.

When you die, your trustees will be able to pay your nominated beneficiaries immediately and directly, according to your wishes, without that lump sum being included in your estate for probate and thereby making it exempt from any potential IHT calculation.

It isn’t difficult or complicated to set up a life insurance policy with this structure, but it is a good idea to ask a professional adviser like Oportfolio to do this for you to ensure it is watertight, properly reflects your wishes and meets all the tax tests that might potentially be applied to it.

A further advantage of setting up your life insurance in a discretionary trust is that it ensures a definite outcome even if you were to die without a will.

If you haven’t reviewed your life insurance cover and needs for a while, maybe now is a good time to do so. Why not get in touch with a member of our friendly team and see how Oportfolio can help to give you and the people you love financial security for an uncertain future.

Please note: all information contained within this article was accurate at the time of publication.

Oportfolio Limited is an appointed representative of Primis Mortgage Network, a trading name of First Complete Limited which is authorised and regulated by the Financial Conduct Authority

 Your property may be repossessed if you do not keep up repayments on your mortgage.

Oportfolio Ltd fees are payable on application. We charge a broker fee for property purchases of £495 and a remortgage/further advance fee of £395. Our product transfer fee is £295.

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