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.

What "in your estate" actually means

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.

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.

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. 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. 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.

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 — Trusts and Inheritance Tax (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. Last reviewed 12 September 2026.