Life Insurance and Inheritance Tax: Why Writing a Policy in Trust Matters

There is a box on most UK life insurance applications asking whether you want the policy written in trust. It costs nothing, takes a few minutes, and a great many people tick past it because it sounds like something for wealthy families with estates to plan.

It is not. For an ordinary household with a mortgage and a life policy large enough to clear it, that box is frequently the difference between a payout arriving in weeks and arriving after probate, and between the money going to the people you named and 40% of part of it going to HMRC.

This applies to the United Kingdom. The inheritance tax figures below come from GOV.UK and HMRC's own manuals. In India the question is about income tax rather than inheritance tax, and the answer is different: see whether a life insurance payout is taxable in India.

Which of the three taxes this page is about

Three different taxes sit behind the question, and for an ordinary UK protection policy only one of them usually bites. Inheritance tax is the one this page is about. Getting the other two out of the way first makes the rest of it easier to read, and the full treatment of all three, with HMRC’s own worked example, is in is a life insurance payout taxable in the UK.

Income tax. HMRC's helpsheet HS320 (opens in a new tab) treats the death of the life assured as a chargeable event, but measures any gain from the policy's surrender value immediately before death rather than from the sum the insurer pays. A protection policy has little or no surrender value, so that calculation usually produces nothing. Investment-linked policies are where a gain genuinely can arise.

Capital gains tax. The wrong regime entirely. HMRC treats a chargeable event gain as income rather than as a capital gain, which is why neither capital losses nor the annual exempt amount have anything to do with it.

Inheritance tax. This is the one that catches ordinary households, and it catches them through the estate rather than through the payout. That mechanism is what the rest of this page explains.

What HMRC's rules actually say about life insurance and inheritance tax

Your estate is everything you own when you die: property, savings, possessions, and (if it is not held elsewhere) the proceeds of a life insurance policy on your life.

HMRC's inheritance tax manual (opens in a new tab) states it plainly. If the deceased is the life assured, the proceeds are payable to whoever owns the policy or to a person named in its terms, and where the deceased owned it, those proceeds form part of their free estate, so they will be taxable on their death.

That is the whole problem in one sentence. The policy you bought to protect your family is, by default, one more asset in the pot that gets valued and taxed.

The thresholds the payout runs into

GOV.UK (opens in a new tab) sets out the position:

Two features of that table decide whether any of this affects you.

The threshold is transferable. If you are married or in a civil partnership and your estate is below your threshold, the unused part can be added to your partner's when they die. A couple can therefore pass on substantially more than one person can.

Property does the damage. £325,000 sounds generous until you put a house in it. An estate that was comfortably under the threshold on the strength of the house alone can be pushed over it by a life insurance payout, and the tax at 40% falls on the excess.

There is a second reason the estate route is worth avoiding, and it has nothing to do with tax: whatever lands in your estate is then divided according to your will, or (if you do not have one) according to the intestacy rules, which are fixed by law and may not match what you intended.

A worked example

Take a single parent whose home passes to their children. Their estate looks like this:

Their available threshold is £500,000: the standard £325,000 nil-rate band plus a £175,000 residence nil-rate band (opens in a new tab) because the home goes to direct descendants. No inheritance tax is due.

Now add a £200,000 life insurance payout that is not in trust. The estate becomes £600,000.

The family loses £40,000 and waits months for probate. Written in trust, the same money arrives in weeks and costs nothing in tax.

The delay nobody plans for

Tax is the headline. Timing is what families actually notice.

Money that forms part of your estate cannot be paid out until the estate is administered, which means waiting for probate. That process takes months, not days. In the meantime the mortgage still falls due, the bills still arrive, and the person dealing with all of it has just been bereaved.

A policy written in trust does not sit in your estate, so it does not wait for probate. The trustees can claim and distribute it directly.

For a household whose life cover exists specifically to clear a mortgage, that difference is the point of buying the policy in the first place.

What a trust actually is here

Three roles, and on a simple policy trust they are not complicated:

• The settlor: you. The person putting the policy into trust.
• The trustees: the people who hold the policy and claim it when the time comes. You are normally one of them, plus at least one other person you trust to act.
• The beneficiaries: the people the money is for.

Insurers provide their own standard trust forms for exactly this purpose, and completing one at application typically costs nothing. Doing it later is usually still possible but is a transfer, which brings its own considerations, so the cheap moment is at the start.

Moving a policy you already have into trust

Most pages that mention this say there "may be tax implications" and stop. Here is the actual rule, because it decides whether the move is trivial or expensive, and the answer depends on which kind of policy you hold.

Putting an existing policy into trust is a gift. The question is what the gift is worth, and the instinctive answer — a term policy has no surrender value, so the gift is worth nothing — is right for most people and wrong for some.

The default is open market value. But IHTA 1984 section 167 (opens in a new tab) imposes a floor on lifetime transfers of life policies. HMRC's manual puts it plainly: the rules provide a minimum value which is, broadly, the amount of the premiums paid less any sum received under the policy before the transfer, and that figure is used only if it exceeds the open market value.

Read that twice if you have been paying into a policy for a decade. It means the gift can be measured by what you have put in rather than what the policy would fetch.

Most term assurance escapes it. HMRC excludes term policies from the special rule (opens in a new tab) where the sum assured becomes payable only if the life assured dies before the end of a specified term. Where that term ends more than three years after the policy was made, two further conditions apply: premiums must be payable during at least two thirds of the term and at yearly or shorter intervals, and the premiums in any twelve-month period must not be more than twice those in any other twelve-month period.

An ordinary level term policy paid monthly clears all of that without anyone having to think about it.

Once you know the value, it behaves like any other gift: into a bare trust it is a potentially exempt transfer that drops away if you survive seven years, and into a discretionary trust it is a chargeable transfer tested against the nil-rate band at the time. Which of those you are making is the subject of the bare trust and discretionary trust comparison.

Death in service: your work cover is probably already handled

If you have life cover through your employer — a death-in-service benefit — it is almost certainly held in a discretionary trust already. The scheme trustees, not you, own the policy. They decide who receives the payout, guided by the expression-of-wishes form you filled in when you joined.

Because the trustees have discretion, the benefit sits outside your estate automatically. You do not need to tick any box or set up any trust yourself. The government has confirmed (opens in a new tab) that death-in-service benefits payable from a registered pension scheme remain excluded from the new inheritance-tax-on-pensions rules taking effect in April 2027, even as most other unused pension funds are brought within scope. We cover those changes in detail in the pensions and inheritance tax guide.

The distinction matters: personal life insurance needs a trust set up deliberately; employer death-in-service cover already has one. If you hold both, the employer cover is probably fine and the personal policy is where the trust question actually lives.

One thing to do regardless: check that your expression-of-wishes form is current. It is not a will, and trustees are not legally bound by it, but it is the document they reach for first. Marriage, divorce or a new child all change who you want on it.

The tax rules that do apply to trusts

A trust is not a magic box outside the tax system, and anyone telling you otherwise is overselling it. GOV.UK sets out (opens in a new tab) three occasions when inheritance tax can arise on a trust:

1. When assets are transferred in.
2. At each ten-year anniversary of the trust: the periodic charge.
3. When assets leave, or the trust ends: exit charges.

In practice a term life policy held in trust usually has little or no value while the life assured is alive, which is why these charges are frequently immaterial for a straightforward protection policy. But "usually" is doing real work in that sentence: the position depends on the type of trust, what else is in it, and the values involved. Which type you are offered is itself a decision with consequences, and the difference is set out in bare trust versus discretionary trust for a life policy. Whole of life and investment-linked policies are a different proposition from level term cover.

This is the point at which a solicitor or a qualified adviser earns their fee, and the one part of this article I would not act on without one.

Paying premiums, and the gift rules

If you pay premiums on a policy held in trust, or on a policy someone else owns, those payments are gifts. HMRC's manual says the premium amount, after any exemption, may be a Potentially Exempt Transfer or a chargeable transfer.

That sounds alarming and usually is not, because of the exemptions GOV.UK lists (opens in a new tab):

• Normal expenditure out of income. There is no limit on regular gifts made from your income, provided you can still meet your usual living costs. Monthly premiums paid from salary are the textbook case, and this is the exemption most protection policies rely on.
• Annual exemption: £3,000 of gifts per tax year.
• Small gifts: £250 per person per tax year, provided you have not used another allowance on that person.
• Wedding gifts: £5,000 to a child, £2,500 to a grandchild or great-grandchild, £1,000 to anyone else.

And the seven-year rule: no tax is due on gifts if you live for seven years after making them. What taper relief does and does not do is set out in the guide to the seven-year rule. Where tax does apply to a gift made three to seven years before death, taper relief reduces it:

Taper reduces the tax, not the value of the gift, and only bites where the gift exceeded the nil-rate band. It is widely misread as a discount on the gift itself.

Using life insurance to pay an inheritance tax bill

This is the opposite question to the rest of this page, and it is worth separating out. Everything above is about stopping a payout from being taxed. This is about a bill you already expect — usually an estate carried over the threshold by a house — and whether cover can fund it rather than reduce it.

It can, and the reason is timing as much as money. GOV.UK (opens in a new tab) requires inheritance tax to be paid by the end of the sixth month after the person died, and probate is generally not granted until it has been. That is the trap: the cash that would settle the bill is usually locked inside the estate being taxed, and the estate cannot be unlocked until the bill is settled. A policy held in trust pays the trustees directly and outside that queue, which breaks the deadlock without the family having to sell the house in a hurry.

Four things decide whether it works.

For a couple, it is the second death you are insuring, not the first. Transfers between spouses and civil partners are exempt, so the first death usually produces no inheritance tax at all: the estate passes to the survivor untaxed, and the unused nil-rate band transfers with it. The bill arrives when the second of you dies and the whole estate passes to the children. That is why cover written for inheritance tax funding is normally joint life, second death, and why the joint-life-first-death policy most couples already hold alongside a mortgage is solving an entirely different problem. Assuming the mortgage policy also covers the tax bill is a common and expensive mistake, because it pays at the one death where there is usually nothing to pay.

It must be written in trust, or it makes the problem worse. A policy bought to cover an inheritance tax bill and left in your own name is added to the estate and taxed at the standard 40% rate (opens in a new tab) along with everything else. You would be funding the liability and enlarging it in the same move. It is the same trust point as the rest of this article, applied to the opposite purpose, and it is the mistake most worth avoiding here.

The cover has to outlast you. Term assurance expires. Where the liability is permanent — and for an estate whose value sits in property it usually is — cover that ends on a fixed date removes the funding and leaves the bill. Whole-of-life cover is the usual answer, and it costs materially more than term for the same sum assured, because it is certain to pay out rather than merely likely to. Guaranteed and reviewable premiums are also not the same thing: a reviewable premium can be re-rated upwards at review, which is a different risk from the one you set out to insure.

The premiums are gifts, and usually exempt ones. As set out above, regular premiums paid from income normally fall within normal expenditure out of income, which has no upper limit. That exemption is what stops the arrangement cancelling itself out. It is worth keeping a record of the income the premiums are paid from, because your executors will have to evidence it at a point when you are not available to explain it.

Cover for a gift you have already made

A narrower case. If you make a large gift and die within seven years, tax can fall on it, reducing on the scale in the table above. A gift inter vivos policy is decreasing term assurance written to track that scale: cover that steps down as the liability does, and ends after seven years.

It is only worth considering where the gift exceeded the nil-rate band, because taper relief reduces the tax actually payable rather than the value of the gift — the distinction set out in the guide to the seven-year rule. Below that threshold there is frequently no tax to insure against in the first place.

The sums here are larger than on a straightforward protection policy, the choice of trust matters more, and the periodic and exit charges described above stop being immaterial. This is firmly adviser territory, more so than anything else on this page.

What you give up, and when a trust is the wrong answer

Every page on this subject, including the one you are reading until this paragraph, argues for the trust. The honest version has a cost side, and it is not nothing.

You are giving the policy away, and that is the point rather than a side effect. The payout escapes your estate because it is no longer yours. On a bare or absolute trust the beneficiaries are fixed when you sign, and you cannot later swap a named child for a new partner, add a child born afterwards, or take the policy back because circumstances changed. That permanence is exactly what satisfies HMRC, and exactly what people regret when their family looks different a decade later. A discretionary trust buys back most of that flexibility, which is why it exists — and pays for it with the charge regime set out above.

The money goes to the beneficiaries, not to whoever needs it. Trustees must follow the trust. If the person who actually needs the cash is not a beneficiary, the trust is the reason they cannot have it.

Someone has to be a trustee, for decades. Trustees have to be findable and willing at the moment of a claim. Trustees who have emigrated, fallen out with the family, lost capacity or died are a problem discovered at the worst possible time, and replacing them is an administrative job somebody has to notice is needed.

It can be the wrong answer entirely. Three common cases where the trust adds paperwork and nothing else:

• Everything goes to your spouse or civil partner. Transfers between spouses are exempt without limit, so there is no inheritance tax to avoid. A trust may still be worth it for the probate timing described above, but the tax argument does not apply.
• The estate is comfortably inside the available thresholds. Below the nil-rate band, and the residence nil-rate band where it applies, there is no charge for the trust to prevent. The residence nil-rate band has its own conditions, and an estate near £2 million should check the taper before concluding it is safe.
• It is employer death-in-service cover. Already in a discretionary trust, as set out above. Doing it again is not possible and not necessary.
• The policy can also pay out while you are alive. Cover combining life and critical illness is a different proposition, because a standard trust hands the critical illness payment to the beneficiaries as well, at the moment you are most likely to need it yourself. What critical illness cover and income protection each actually do is worth settling before deciding whether a combined policy belongs in a trust at all. A split trust exists for exactly this problem, and it is not one of the standard forms.

What to actually do

1. Find out whether your policy is in trust. Most people do not know. Ask your insurer directly; they will tell you.
2. Work out roughly what your estate is worth, including property and the policy. If the total is comfortably inside the available threshold and everything passes to a spouse, tax is not your issue: probate timing still might be.
3. If it is not in trust and the money is for children, an unmarried partner, or anyone outside the spouse exemption, take advice about putting it in trust. This is the case where it matters most.
4. Check who the trustees are if it is already in trust, and whether they are still the right people. Trustees who have moved abroad, fallen out with the family, or died are a problem discovered at the worst moment.
5. Review it when circumstances change: marriage, divorce, children, a new mortgage.

A trust and a will do different jobs. The trust decides what happens to one policy; the will decides everything else. If you have neither, the law decides both.

The box on the application form is worth the five minutes. That is genuinely the whole point of this article.

Sources

• HMRC: Inheritance Tax Manual, IHTM20012: life policies and Inheritance Tax (opens in a new tab)
• GOV.UK: How Inheritance Tax works: thresholds, rules and allowances (opens in a new tab)
• GOV.UK: Inheritance Tax on gifts (opens in a new tab)
• GOV.UK: Pay your Inheritance Tax bill (opens in a new tab)
• GOV.UK: Trusts and Inheritance Tax (opens in a new tab)
• HMRC: HS320 Gains on UK life insurance policies, Self Assessment helpsheet (opens in a new tab)
• GOV.UK: Residence nil-rate band (opens in a new tab)
• GOV.UK: Technical note — Inheritance Tax on pensions (death-in-service exclusion) (opens in a new tab)
• HMRC: IHTM20241 — IHTA84/S167, the minimum value rule for gifted life policies (opens in a new tab)
• HMRC: IHTM20242 — exclusions from the special rule (opens in a new tab)
• HMRC: IHTM20243 — term assurance policies excluded from the special rule (opens in a new tab)

This article is general information for a United Kingdom audience and applies to England and Wales unless stated; Scotland has a different succession regime. It is not financial, tax or legal advice, and it does not recommend any insurer, policy or trust arrangement. Inheritance tax thresholds and trust rules change, and the right answer depends on your own estate, your marital status and the type of policy you hold. Take advice from a solicitor or a qualified adviser before putting a policy in or out of trust. The section 167 valuation rules and the term-assurance exclusions were checked against HMRC’s Inheritance Tax Manual on 21 October 2026. Last reviewed 21 October 2026.