I don’t know about you, but when I use social media these days I get bombarded with life insurance adverts. Most of these seem to be targeted at people my age (nearer 50 than 40) who haven’t got round to buying life insurance (I did years ago). Some of the ads have also been in dubious taste, although I didn’t see this notorious ad on my Facebook feed. However, given that the average life insurance payout is over £80,000 I thought it worth looking into the relationship between life insurance and Inheritance Tax.
Why look at life insurance and Inheritance Tax?
We’ve written about how Inheritance Tax (IHT) works elsewhere on this blog. You can read about it in more detail here. What we need to know for the purposes of this article is that everyone can leave an estate worth up to £325,000 without having to pay IHT. If someone dies and leaves their estate to their spouse, their tax-free allowance doubles to £650,000.
Either way, it’s worth considering what happens to the estate after a life insurance pay-out. In normal circumstances, this money is added to your estate because it is an asset. This can cause problems. Imagine you’re a single person and your estate is worth £300,000. A life insurance pay-out is added to your estate, bringing its value up to £380,000.
If this happens, the £55,000 above the tax-free allowance would be liable to Inheritance Tax at 40%. This would mean an IHT liability of £22,000.
(Note, there are possible reliefs and exemptions, but for simplicity we won’t cover those here).
Can I avoid adding a life insurance pay-out to my estate?
Yes, it is possible to make life insurance and Inheritance Tax work better together. One common way of doing this is to put your life insurance in trust. Essentially, you set up a legal arrangement to give ownership of your policy to your named trustees (normally your family and loved ones).
Once you do this, the policy no longer belongs to you. This means it can’t be added to your estate. You can specify that the trust pays out on your death or at another time. For example, it could pay out when a grandchild turns 18.
There are various different types of trust you can set up. A THP advisor can talk you through your options, but there’s another major benefit to trusts. This is that, because a trust isn’t part of your estate, your beneficiaries don’t need probate to access it. This means it could pay out very shortly after your death.
Using life insurance to pay your IHT bill
If you put a life assurance policy into trust and it means your estate is no longer liable for IHT, then that’s great news.
However, if your estate is still liable for IHT, you may be able to take out another insurance policy to help pay for it. Usually you would take out a ‘whole of life’ policy that pays out whenever you die. This is in contrast to a ‘term’ policy that pays out only if you die within a specific period.
It’s worth remembering, though, that the later you take out a whole of life policy, the less the pay-out will be. It’s also a good idea to talk to an expert about whether to put such a policy – or any other policy – into trust.
I need help. What do I do next?
If you would like more help planning for IHT, we strongly recommend our Inheritance Tax Planning service. Our expert advisors will help you understand the relationship between Wills, trusts, reliefs and gifts – and create an effective IHT planning strategy that’s tailored to your specific needs. Get in touch today to learn more.
About Ben Locker
Ben Locker is a copywriter who specialises in business-to-business marketing, writing about everything from software and accountancy to construction and power tools. He co-founded the Professional Copywriters’ Network, the UK’s association for commercial writers, and is named in Direct Marketing Association research as ‘one of the copywriters who copywriters rate’.