Ask Sindie: how to buy cover and avoid a tax trap

Your money problems solved

My partner and I have just had our second child and want extra life cover to minimise the financial difficulties if one of us should die.

Q. My partner and I have just had our second child and want extra life cover to minimise the financial difficulties if one of us should die.

A financial adviser friend tells me new policies should be put in trust to prevent any payout being included in either of our estates for inheritance tax [IHT] purposes.

It sounds complicated and expensive but I'm keen to do it if it could save money. How should I go about arranging a trust? If it makes any difference, we're not married.
DR, by email

A. Simple life cover that pays out on the death of the person insured at any point during its agreed "term" - usually 25 years - can soften the blow to a family's finances at a time of great emotional stress.

Yet many people don't realise that when they die, life insurance payouts are regarded as part of their estate and could count towards an IHT bill.

The taxman can take 40 per cent of any sum over £263,000, and rising property prices have left millions of people with assets above this threshold. Whether or not this applies to you, an insurance payout could push up the size of your estate and catch you in the IHT net.

Writing your cover "in trust" means that if you or your partner were to die (assuming you have each taken out a policy or bought joint cover), the money will bypass the taxman and be channelled into the trust instead for distribution to the surviving partner and children.

Even though the tax rules for married couples mean life-insurance payouts pass to spouses free of IHT, it is still a good idea for life cover to be written into trust. This usually ensures a speedier payout if one partner dies, since the money won't be held up while the will is in probate.

Creating the trust should be neither difficult nor expensive, although the cost will depend on where you buy it. First ask a policy provider (which may be a life assurer, broker or even a supermarket) if they include a trust form for free - or if there is a charge for doing so.

"It costs the provider a bit more to process [the policy], which is why some don't like to promote trusts," says Jason Wyer-Smith of Virgin Money.

If you buy life cover through a broker or financial adviser, a small sum - around £10 - is sometimes added to your bill to put the policy in trust.

Since you're creating a trust, you have to name beneficiaries and sign a legal document before witnesses - usually friends or family. As a general rule, if you're single with dependants and don't have complicated finances better served by separate trust planning, it will be worth writing your policy into trust.

If you need financial advice or help from our consumer champion, write to Sindie at The Independent on Sunday, Independent House, 191 Marsh Wall, London E14 9RS or email sindie@independent.co.uk. We cannot return documents, give personal replies or guarantee to answer letters. We accept no legal responsibility for advice given.