Your Money: Don't allow the taxman to get in bed with your legacy

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The Independent Online
THEY may be your Valentine. But if you are not married to them and you were to die, there is a good chance the payout on any life insurance policy would be held up and face tax.

This is not an argument for marriage but rather for taking some simple action, usually at minimal cost, to sidestep unnecessary tax and delays. Many life policies that should be are not written "in trust", say financial advisers and insurance companies. It is worth checking on the status of your policy.

When individuals die, their assets often become stuck in a form of financial suspended animation before a grant of probate allows distribution according to the terms of a will. This can take the best part of a year, and even longer if the estate is complicated. After probate, there is often inheritance tax to be paid. Without even a will, inconvenience can become disaster.

There is no inheritance tax liability on payments to wives or husbands. But for the unmarried, writing a policy in trust should also mean that the payout falls outside the inheritance tax net. Otherwise its value is taken into account for assessing any tax liability when you die. Only the first pounds 154,000 of an estate, pounds 200,000 from April, including the value of your property, is tax-free.

In addition, even husbands and wives can benefit from avoiding the delays involved in waiting for a grant of probate. Directing the proceeds of a policy to benefit a specific person by way of trust bypasses the legal hold-up and can ensure that, for example, a surviving partner has use of the money six or nine months earlier.

Trusts need not cost anything to set up or run. Insurers may well be able to help with appropriate forms in some cases, but time may be well spent seeking independent advice. A professional adviser will be able to select an appropriately worded trust document and ensure that the cover you are contracting to pay for will go to the right place at the right time, and without any windfall gifts for the taxman.

A trust provides an "envelope" around a policy that allows the person paying the premiums to indicate who should benefit from the proceeds on death. Trustees must be appointed, whose role is to pay the money to the beneficiaries. Despite the crusty term, "trustees" do not have to be professionals charging hefty fees, but can include the policyholder, a spouse, siblings and friends. As no individual trustee can act without the agreement of all the others, problems of misappropriation of the money should never arise. Indeed, if the named trustees include the intended beneficiaries, there is unlikely to be any great delay in their giving the money to themselves.

It is usually possible to write a policy in trust even many years after it was taken out. Some policies, however, may still remain potentially liable for inheritance tax if you do not survive the subsequent seven years.

But some life insurance policies should not be written in trust. Peter Kelly, the head of protection at Allied Dunbar, said: "Never write anything in trust that you want to benefit from yourself, for example, a critical illness policy. Also, you will probably find that where collateral security is involved, with a mortgage or loan, say, the lender will not normally allow the policy to be written in trust. Obviously, if the policy cover is greater than your borrowings, there may well be room for manoeuvre with the excess."

Personal pensions, however, should always be written in trust to ensure that the death benefit, normally the value of the accumulated fund, is free of inheritance tax.