Wills and life insurance policies
An effective combination when set up correctly, a disaster waiting to happen when not?
You have a will in place. You've worked out what happens when you die, what happens when your spouse dies, and when the children eventually get to inherit.
You also have one or more life insurance policies in place. Somewhere. From years ago. You think.
A good question, and one that inevitably gets overlooked until it is too late, is whether your will and your life insurance policies work well together?
Nominations to individuals
To illustrate, younger clients preparing their first will often want to ensure that their surviving spouse is provided for, but that ultimately their estate passes to their children. Protection from the surviving spouse's potential divorce or bankruptcy is the main concern.
Such clients are often advised to gift their estates to a trust, so that the trustees can balance the competing interests of the surviving spouse and children, ensuring that the surviving spouse is provided for but at the same time protecting the value ultimately for their children.
However, very often those same clients will also have life insurance policies in place that are nominated to pay out to the surviving spouse, or worse to nobody if no nomination has been made.
The life insurance policies typically represent a large proportion of their overall wealth, which all passes to the surviving spouse and is then potentially at risk from a subsequent divorce or bankruptcy.
Similarly, older clients who are more concerned with inheritance tax planning, may consider using trusts in their will to skip a generation tax efficiently, but again often have life insurance policies in place that are nominated to pay out to the survivor and therefore simply add taxable assets to the survivor’s estate which defeats any well thought out tax planning.
Nominations to trust
As an alternative to nominating that their life insurance policies are to pay out to the surviving spouse or children on the event that they die, clients may want to consider nominating to a trust instead.
Nominating to a trust enables you to choose who acts as trustee and manages the life insurance proceeds when you die and to then guide your trustees as to what is to happen to those proceeds. Importantly, by nominating the proceeds to a trust, the proceeds fall outside of your estate for inheritance tax purposes, and so will be distributed by the trustees as tax free cash.
Your trustees could:
- Use the life insurance proceeds to help fund any other inheritance tax liability;
- Hold onto the life insurance proceeds until they are certain your surviving spouse does not need any additional capital or income, then distribute to your children thereby not adding taxable assets to your spouse’s estate; or
- Hold onto the life insurance proceeds until your children’s circumstances are settled and the risk of divorce or bankruptcy for your surviving spouse, or for your children, as adults, is minimal.
Our advice is quite simple. When reviewing your will and estate planning, always review your life insurance policies at the same time.
When advising clients who do not have a financial adviser already, we will always look to make an introduction to one or more trusted independent financial advisers, who can often carry out an initial review for you at no cost.
If you already have a will in place that you are certain does not need reviewing, still search out those old policies to check the position.
A ten minute search for the papers and a quick telephone call could end up saving you and your family significant cost, tax and hassle in the future.
If the content of this update raises any issues for you, or you would like to discuss, please liaise with David Stokes, Principal Associate at firstname.lastname@example.org.