How life insurance could help your family mitigate Inheritance Tax
Last month, you might have read our breakdown of five stealth taxes that could put a strain on your wealth in the 2024/25 tax year. A “stealth tax” describes the freezing or reducing of tax-efficient thresholds that may result in taxpayers paying a greater sum over time.
One such tax was Inheritance Tax (IHT).
Here’s why IHT is currently considered a stealth tax:
- The nil-rate bands, which limit how much you can pass down as inheritance without an IHT bill, have been frozen until 2028.
- The nil-rate band stands at £325,000.
- There is an additional residence nil-rate band of £175,000, which can usually be claimed by those inheriting a family home from their parent, grandparent, or great-grandparent. Stepchildren also count within this rule. If your estate is worth more than £2 million, you may not benefit from the whole residence nil-rate band, as it is likely to be tapered.
So, while you could benefit from passing up to £500,000 down to the next generation tax-free, or £1 million if you combine your allowance with that of your spouse or civil partner, the freezing of the nil-rate bands could pose a problem. If your estate rises in value while the thresholds are fixed, a greater portion of it could be subject to IHT.
If you are beginning to form your estate plan, there are plenty of strategies you could consider for lowering the amount of IHT your loved ones might have to pay, or indeed for helping them pay an eventual bill.
One often-overlooked strategy is using life insurance.
Find out how life insurance could play into your estate plan, plus how your financial adviser can help you put your ideas into motion.
A life insurance payout could be used to pay off Inheritance Tax
Life cover is designed to help your family cover essential costs if you pass away within the policy term. These could be ongoing costs, such as your mortgage, or one-offs like funeral fees.
According to the latest data from Forbes, the average life insurance payout in the UK stands at £73,578 – a significant sum that could ease your family’s financial stress in a time of grief.
However, life insurance could be counted as part of your estate when you pass away. This means that a payout may be combined with other assets you leave as inheritance, like property and shares, and may contribute to pushing the value of your estate above the nil-rate bands.
You might be wondering: “If life insurance will make my IHT bill higher, how can I possibly use the payout to foot the bill?”
That’s where the next piece of the puzzle comes in – keep reading to find out two stipulations that could shield your cover from being counted within your estate.
2 stipulations around life cover and Inheritance Tax you need to know about
1. Wrapping your life cover in trust could shield it from Inheritance Tax
Placing your life cover in a trust usually protects it from IHT.
You could consider wrapping your life insurance in a discretionary trust, absolute trust, or flexible trust in order to protect it from IHT and ensure your beneficiaries are entitled to the full amount. The rules around trusts are incredibly complex, so it may be worth talking to your adviser about options that suit you.
Put simply, a trust allows you to name the beneficiaries you would like to receive the funds and elect trustee (usually a minimum of two close friends or family members) who can oversee the transition of wealth. With some types of trust, the trustees may be allowed to apply their own discretion to your stipulations.
Placing life insurance in trust means the entire sum could be utilised upon your death – including, crucially, to pay an IHT bill.
If you opted for this strategy, your beneficiaries may then enjoy a greater amount, or the full amount, of wealth that you leave behind, while your life cover payout takes care of the tax bill.
Of course, there is no guarantee that a life cover policy will pay out – more on this in the next section.
If you’re considering wrapping your life cover in a trust to cover IHT, it could help immensely to discuss this option with your financial adviser, who can answer any questions you may have.
2. It may be worth taking out whole-of-life cover, otherwise known as life assurance
We all hope to live a long, full life.
Yet seeing as most term life cover policies lapse on the date initially set by the provider or on the date requested when you set up the policy, it could be worth considering whole-of-life cover, also known as “life assurance”. This may help to ensure your beneficiaries have every likelihood of receiving a payout.
Whole-of-life cover does exactly what its name describes – it offers life insurance cover for your entire life, no matter how long you live. This means your family is essentially guaranteed to receive the agreed upon amount when you pass away, normally as a lump sum.
While life assurance won’t reduce the amount of IHT your family pays, it could help them to cover the cost of an IHT bill and benefit from a greater portion of your estate after you pass away.
Get in touch to learn how financial advice could transform your estate plan
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Email info@chancellorfinancial.co.uk, or call 01204 526 846 to speak to an adviser.
If you’re already a client here at Chancellor, contact your personal financial adviser to discuss any of the content you’ve read in this article.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, or will writing.
Note that life insurance plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.
Cover is subject to terms and conditions and may have exclusions. Definitions of illnesses vary from product provider and will be explained within the policy documentation.
