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Writing the mortgage life insurance policy into a trust

The amount of mortgage life insurance can be decreasing or level. For decreasing mortgage life insurance, the type of mortgage usually covered is a repayment mortgage. For a level mortgage life insurance, an interest-only mortgage is usually in use. However, there is a third option – a mortgage life assurance policy. (What is mortgage life assurance?)

Essentially, mortgage life assurance is used in an endowment mortgage, where the proceeds of an endowment life insurance policy will be used to pay the principal at the end of the mortgage term. Hence, the term mortgage life assurance was coined.

Unlike other mortgage life cover, where the lender is named as the beneficiary, here, it is the policy owner who receives the endowment and who then uses that to pay off the interest-only mortgage.

Mortgage life assurance and inheritance tax

Some common terms used in trusts:

Asset. A property or item that has value. This can be real estate, stocks and bonds, jewelry or insurance policies.

Beneficiary. A person who is an heir of the decedent’s estate. This can also be someone who the decedent has assigned to receive the proceeds of a life insurance policy.

Decedent. The deceased person who owns the property that is now being held probate.

Executor. The person the decedent has assigned to ensure that the will is followed.

Inheritance Tax. This is levied on a decedent’s estate, as well as on trusts and gifts made while the person is still alive. Currently, the tax payable is 40% over assets above £325,000. This will apply until the tax year 2014/15.

Probate. The process involving the gathering of a decedent’s property, clearing all taxes and debts and the distribution of the remaining balance the way the decedent wants them distributed, as stipulated in is will.

Trust. A legal arrangement that aims to avoid probate. The assets are transferred to the trust by its owner while he is alive so that the trust owns the property and survives even when its creator dies.

Trustee. The person that has been assigned to manage the trust.

Since mortgage life insurance designed to cover an endowment mortgage may be considered as a life assurance policy, if it is not placed in a trust, it may be counted as part of your estate when you die. When this happens, the proceeds of the insurance may be subject to inheritance tax, as well as other fees.

The estate will also be used to clear any of your outstanding debts. Before the estate is divided to your heirs, any claims from debtors will first be cleared. Other fees will also be deducted from the estate – these include probate fees and solicitor’s fees.

The problem with this is that when the Person Insured dies:

To protect the insurance proceeds from this, you can write the policy into a trust. The trust ensures that the proceeds of the mortgage life insurance go to the Person Insured’s intended beneficiaries.  When the trust is set up, you can indicate the people who will be the beneficiaries.

For the mortgage life insurance policy, the beneficiary may be the lender or the person you have assigned to pay up the mortgage with the lender. This means you are able to give away your assets without the intended beneficiaries having to wait for the estate to be settled.

With the trust, the insurance proceeds will be paid more quickly and directly to the lender. Also, the proceeds can be protected against any possible claims from the estate (such as existing debts and obligations) – which means that the lender can get the proceeds free and clear.

If you took out the mortgage life insurance policy jointly with your spouse, you don’t need to write the mortgage life insurance policy into trust. What will happen is that the insurance company will pay the proceeds directly to the surviving partner.

Writing a policy in trust is relatively easy. When you apply for your policy, the application has an option to write in trust directly. There will usually be no charge for this. The drawback with writing the policy to trust is that you may have less control over your policy. It is usually difficult to cancel a trust once this has been set up. Even when you have the permission or agreement from the beneficiaries, you cannot easily change some aspects of the policy.

Since your particular situation and how a trust can be applied should be based on existing regulations, it is best to ask the advice of an experience insurance agent to guide you through.

Latest update: 17.06.2013

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Other sites: critical illness cover, lifeassurance.org.