Put your trust in trusts

... if you don't, says Andrew Couchman, it's the taxman who benefits when you die
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Would you pay 66 per cent more for your life assurance than you need to? Of course not. But unless you use a trust that is effectively what could happen.

Trusts are a peculiar part of English law that fall into the "having your cake and eating it" category. Peter Kelly, life marketing director at Allied Dunbar, explains the attraction: "A trust makes so much sense. For a cost of just one more signature on a form you get two advantages. First, the policy proceeds are paid to the person or people you want without any delay. Second, you avoid having to pay Inheritance Tax of 40 per cent on the proceeds if your estate on death exceeds the starting point of tax. That is currently pounds 223,000, including your home and all life assurance unless written under trust."

The low cost of term assurance today can also mean paying the tax even where you have few other assets.

Anne Young, technical support manager at Scottish Widows, says that for many people this is a nightmare waiting to happen. "If your estate is subject to Inheritance Tax, pounds 100,000 of cover provides only a net pounds 60,000 to your beneficiaries, with the taxman taking the remaining pounds 40,000."

A trust works because legally it is a gift - in this case, of the policy premiums. As these are small compared with the sum assured they invariably fall into one of a number of annual exemptions allowed under the Inheritance Tax rules.

Some people are put off trusts by fear of the legal terms used but there are just three that will concern you. In England the settler is the person who sets up the trust - ie, you. Scottish law is similar but the equivalent is called a truster. The beneficiaries are those you want to benefit, usually your children or partner. The trustees are the people you appoint to ensure that the policy proceeds go to the right people. Trustees must be 18 or over and could also be beneficiaries.

Older designs of trust are often still written under the terms of the Married Women's Property Act of 1882 which first allowed women to leave property and appoint beneficiaries at the outset with no option to change in the future. The modern trend is to use a flexible trust so that you can make changes later, although you cannot get the benefits back yourself. For example, your partner or spouse could be the beneficiary now and if you have children later on they can be added. The trustees can even change beneficiaries after your death so your will should stipulate what you want to happen then.

Appointing trustees is straightforward but does require careful thought. You could appoint a solicitor or bank trustee company but their fees may be high. Some people will not appoint their partner as a trustee in case they split up later or both die together, and choosing a parent is usually not a good idea as they are likely to die before you do.

To save time your insurer will usually allow you to be the sole trustee initially but to add trustees later. Unless done immediately, this is easily overlooked, causing extensive delays when you die.

As well as financial savings, a trust enables the life assurer to pay out as soon as they are notified of your death. Otherwise, they have to wait until your will is proved or, if you die intestate, until letters of administration have been granted when the laws of intestacy decide who should get your money. "People do not die without a will. You either have your own or the government's will," says Peter Kelly.

Andy Couchman is editor of `HealthCare Insurance Report'.