Business trust: how it protects your share of the business
A business trust is the legal wrapper that makes business protection pay the right people, quickly. If you and your co-owners have shareholder or partnership protection, or are thinking about it, this is how the business trust works, what it costs and what to watch out for.
What is a business trust?
A trust is a legal arrangement where one person or group (the settlor) hands an asset to trustees, who hold and manage it for the benefit of other people (the beneficiaries). A business trust is a specific type of trust used by business owners to hold life insurance or critical illness policies taken out to protect the business.
The term is also used more loosely, particularly in American sources, to describe a trust that owns and runs a business directly. That is a very different arrangement and is covered further down.
In the UK, when an insurer or protection adviser talks about a business trust, they usually mean a discretionary trust form supplied by the insurer. Each business owner puts their own policy into the trust, and their fellow shareholders or partners become the potential beneficiaries. If that owner dies or is diagnosed with a covered critical illness, the trustees receive the money and use it to buy the owner's share of the business from their estate.
How does a business trust work with shareholder protection?
Shareholder protection, and its equivalent for firms, partnership protection, gives the surviving owners the cash to buy a deceased owner's share. The business trust is what connects the policy to that purchase. A typical set-up looks like this:
Each shareholder or partner takes out a life insurance policy on their own life, for the value of their share.
Each policy is written into a business trust at the start. The policyholder is the settlor and usually also a trustee, along with their co-owners.
The other business owners are named as the potential beneficiaries.
Alongside the trust, the owners sign a cross option agreement, which sets out how the shares will be bought and sold.
On a claim, the insurer pays the trustees. The trustees pass the money to the surviving owners, who buy the share from the estate at the agreed value.
The family receives cash for the share, the business stays with the people running it, and nobody has to borrow. The trust and the agreement need to align: the trust decides who receives the money, while the agreement decides what that money must be used for.
Why write business protection in trust?
Without a trust, a life policy owned by a shareholder pays into their own estate. That creates three problems. The money can be stuck until probate is granted, which can take months. It can be counted in the estate for inheritance tax. And there is nothing to stop the family keeping both the cash and the shares.
A business trust solves all three. The proceeds go to the trustees rather than the estate, so they can be paid out as soon as the insurer settles the claim. Because the policy sits outside the estate, it does not normally form part of the estate for inheritance tax. And because the trustees hold the money for the other shareholders, it is used for the purpose it was taken out for.
Policy not in trust
Pays into the estate. Delayed by probate. May be taxed. The family could keep the cash and the shares.
Policy in a business trust
Pays the trustees directly. Available within weeks. Normally outside the estate. Used to buy the share as agreed.
Who are the trustees and beneficiaries of a business trust?
The trustees are the people who hold the policy and decide how to use the proceeds within the terms of the trust. For a business trust, the settlor is normally a trustee, alongside at least one other business owner. It is sensible to add a further trustee so there are always two people able to act if one dies.
The beneficiaries are the people who can benefit. In most business trusts that means the other shareholder or partner owners, and sometimes future owners who join the business. When a shareholder leaves, the trust, the agreement and the list of beneficiaries should be updated so they still match who owns the business assets. Out-of-date trusts are one of the most common causes of a dispute after a claim.
What are the three types of trust?
UK trusts broadly fall into three main types, and the choice matters for tax and flexibility.
Bare or absolute trust
The beneficiaries are fixed and have an absolute right to the trust property. Simple, but inflexible if owners change.
Interest in possession trust
One beneficiary has a right to the income or use of the asset, with the capital passing to someone else later.
Discretionary trust
The trustees decide which beneficiaries receive what and when. Most business trusts from insurers are discretionary, because the owners of a business change over time.
Insurers such as Legal & General, Royal London, Aviva, LV= and Scottish Widows all provide their own business trust forms at no cost when the policy is set up.
Is your cover written in trust?
Book a free trust checkWhat are the advantages and disadvantages of a business trust?
Advantages
- Money is paid quickly to the trustees without waiting for probate.
- The policy is kept outside the deceased owner's estate for inheritance tax purposes.
- Proceeds go to the people meant to buy the share, supporting a smooth succession.
- Discretionary wording copes with owners joining and leaving.
- Setting up the trust costs nothing with most insurers.
Disadvantages
- Once a policy is in trust, the settlor gives up control of it.
- Trustees and beneficiaries must be kept up to date as the business changes.
- Discretionary trusts fall under the relevant property rules, so large sums held for a long time after a claim can face inheritance tax charges.
- The trust does not govern the sale of shares on its own. You still need an agreement drafted, ideally by a solicitor.
How much does it cost to run a trust in the UK?
For a business protection trust, very little. The insurer provides the trust deed free of charge and there are no annual fees. While the policy has no cash value, which is true of most term life insurance, there are usually no ongoing inheritance tax charges either.
Costs arise if you ask a solicitor to draft a bespoke trust or cross option agreement, typically a few hundred pounds upwards. A trust that owns a trading business or investments is a different matter, with legal, accountancy and tax filing costs every year.
Do you need to register a business trust?
Most trusts in the UK have to register on HMRC's Trust Registration Service. However, trusts holding only a life insurance policy that pays out on death, terminal illness, critical illness or disablement are excluded while the policy is in force. If the trustees receive a payout and still hold it more than two years later, the trust must then register. Check the current rules on GOV.UK or with your solicitor.
Can you run a business through a trust?
Yes. Some business owners, mostly in family companies, place shares in a trust to manage succession between generations or to keep ownership together. The trustees then own the shares and exercise the voting rights for the beneficiaries. This is a complex area involving inheritance tax, business relief and capital gains tax, and it is not a structure for sole traders or a simple partnership. Take legal and tax advice before going down this route.
Business trust questions, answered
Can a business trust be changed?
Discretionary business trusts usually allow trustees to be added or removed and beneficiaries to be varied as owners join or leave.
Is a business trust the same as a key person policy?
No. Key person insurance is normally owned by the company and paid to the company, so it is not written in a business trust.
What happens if a policy is not in trust?
The payout goes into the owner's estate, may be delayed by probate and may be subject to inheritance tax.
Get your business protection set up properly
We arrange shareholder protection and partnership protection from across the market and complete the business trust paperwork with you. Book a free call to check your cover and your trust.
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