Life assurance for couples

Summary

Where couples are looking to set up term assurance policies, the fundamental choice is between a joint life policy, payable on the first death or two single life policies.

Often a joint life policy is used, as that’s the cheapest, but there are other factors to consider. In this Bulletin we consider the options available and the benefits, or otherwise, of those options.

Facts and analysis

Using a joint life, first death policy.

With a joint life, first death policy, that is not held under trust, in the event of a claim the policy proceeds are simply payable to, and owned by, the surviving policyholder.  And as that surviving policyholder is now the sole legal owner of the policy, payment can be made without the requirement of probate. 

So far we have only considered the situation where one of the policyholders dies, but what if both die at or around the same time.  In that case, the life policy proceeds will form part of the estate of the second of them to die (if they died at the same time, the younger is deemed to have survived the older).  The proceeds would be part of their taxable estate, could be liable to IHT and would be distributed in accordance with that person’s Will (or intestacy), possibly to someone that the other policyholder would not have wished to benefit. Further, before payment can be made by the life company, probate would be required and, thus, delays could arise.

Consideration could be given to writing the policy into trust, but care would need to be taken over the trust used. On the assumption that the surviving policyholder is to receive the benefits, a life company’s standard discretionary trust is unlikely to be suitable.  This would normally specifically exclude either policyholder from being able to benefit, in order to prevent a reservation of benefits for IHT which would result in the proceeds remaining part of their taxable estate. 

Some providers offer a specially designed trust for use with joint life term assurance policies.  These trusts include provisions to enable a surviving policyholder to receive the policy benefits should they survive a specified period (e.g. 31 days), but for those benefits to be held under trust for the children should both die within that period.  Where the policy proceeds become payable to the children in this way, they will not form part of either policyholder’s estate for IHT purposes.  

But even where a specially designed trust is used, it may still prove to be not as flexible as is required, for example in the event of the policyholders divorce or separate or where for IHT planning purposes, all of the policy proceeds are not to be immediately paid to the survivor.  It would be possible to allow the existing policy to lapse, but arranging replacement life cover on the required basis may not be possible due to changes in their state of health and is likely to come at an increased cost due to being older.  So what are the alternatives?

Using two single life policies held under trust

Two single life policies will be more expensive, but the difference is often minimal.  So it is well worth looking into.  Also, not only does it provide twice the life cover, it is far more flexible arrangement and gives further IHT planning opportunities.    

Each of the couple should take out their own policy, on their own life and then write that policy under trust.  Premiums on each policy should be paid from an account solely in the name of the policyholder and not from a joint account in order to prevent unwanted inheritance tax implications.

A discretionary trust would normally be the preferred choice of trust to use.  This would ensure that the policy proceeds do not fall into the policyholder’s estate for IHT purposes and avoids any probate delays, provided that there are surviving trustees.

Furthermore, additional IHT planning opportunities exist.  Where one life dies, the Trustees are likely to pay the policy benefits to the survivor, as a lump sum. But that simply makes all those benefits an asset of the survivor and would increase the value of their estate and could increase or create an IHT liability on their subsequent death. 

An alternative approach, sometimes referred to as ‘bypass planning', would be to retain the policy proceeds in the trust fund, paying benefits to the survivor as, and when, they require them.  Indeed, many discretionary trusts give powers to the trustees to enable them to make loans to a beneficiary.  Making payments in this way would mean that instead of the value of the beneficiary’s estate being increased, a debt is created (subject to any anti-avoidance legislation).

Example without Bypass Planning

Simon and Rachel are married and have two children, James and Charlotte.  In January 2018, after taking financial advice, it was decided that they needed life assurance cover for £300,000.  Each of them took out a term assurance policy for £300,000 over a 20 year term.  Each policy is held under a discretionary trust. Simon died in 2023 and the Trustees distributed the fund in his discretionary trust to Rachel.  On Simon’s death, all his assets passed to Rachel.  Rachel died on 1 January 2024, with the value of her estate being £950,000. The estate did not include a qualifying residential interest. Her estate passes to her two children.

The inheritance tax payable;

• On Simon’s death.  No IHT is paid, as the benefits of the policy are held under trust, outside of his estate and his estate passes to his wife Rachel.

• On Rachel’s death.  No IHT is payable on the proceeds of her policy as these are held in trust, outside of her estate.

Inheritance tax on Rachel's estate;

£950,000 - £650,000 (her nil rate band (NRB) + 100% NRB transferred from spouse) x 40% = £120,000.

Benefits for the children;

• From Simon’s policy trust – Nil, as all benefits were distributed to Rachel
• From Rachel’s policy trust – £300,000
• From Rachel’s estate – £830,000
• Total – £1,130,000

With Bypass Planning.   

This is the same as the scenario above except that the Trustees decide to loan, interest fee, £300,000 of the trust fund to Rachel. On Rachel’s death, she owns assets worth £950,000,

Inheritance tax payable;

• On Simon’s death.  No IHT is paid, as the benefits of the policy are held under trust, outside of his estate and his estate passes to his wife.
• On Rachel’s death.  No IHT is payable on the proceeds of her policy as these are held in trust, outside of her estate.

Inheritance tax on Rachel's estate;

Although Rachel has assets worth £950,000, her executors will be required to repay the loan of £300,000 to the Trustees of Simon’s discretionary trust.  So the value of the estate for inheritance tax purposes is £650,000. So, the calculation is;

£650,000 - £650,000 (her nil rate band (NRB) + 100% NRB transferred from spouse) x 40% = £NIL.

Benefits for the children;

• From Simon’s policy trust – £300,000 (the loan repayment)
• From Rachel’s policy trust – £300,000
• From Rachel’s estate – £650,000
• Total amount received by the children – £1,250,000 (£120,000 more than without 'bypass' planning)

Also, there are further benefits of using single life policies, where benefits are retained within the trust in addition to the inheritance tax benefit illustrated in the example above;

• Where a client has had children from a previous marriage, they may wish to provide for the needs of their current spouse, whilst also protecting the interest of those children
• To alleviate concerns over the marriage or divorce of a beneficiary. 
• Where intended beneficiaries are too young to receive a lump sum.
• To protect the interest of a vulnerable beneficiary, or one who is mentally incapable or has a special need.
• To protect against the future bankruptcy of a beneficiary. 

Next steps

As can be seen, the cheapest solution is not always the best solution, as there are a number of advantages with setting up two single life policies.  By having a clear understanding of the issues involved, Financial Advisers will be well placed to ‘add value’ when discussing their client’s protection needs.

Important information

This information has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2021. It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice. Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients. You should always seek appropriate legal or other professional advice.