Inheritance tax entered the headlines last year when the Labour government used its first budget to announce measures designed to close loopholes and raise funds, prompting savers and advisers to reconsider their financial planning.
The government’s proposals include plans to impose inheritance tax on unspent pensions from April 2027 and a pledge to reform the non-dom tax regime to slap inheritance tax on assets held in a trust overseas, which have sparked alarm from savers and city figures.
Inheritance tax, often dubbed ‘Britain’s most hated tax’, sits at 40 per cent and is paid on estates worth over £325,000.
The UK’s inheritance tax receipts hit a record high of £7.5bn for the 2023/24 period, a £400m increase on the previous year’s record of £7.1bn.
Prospective inheritance recipients are considering ways to avoid selling their houses to pay stinging inheritance tax bills, and life insurance offers one way of protecting their assets.
“While life insurance does not reduce the overall IHT liability, a policy can be set up to provide a payout specifically designed to cover the tax,” says Daniel Howard, paraplanner at GSB Wealth.
“This ensures that beneficiaries do not have to sell assets, such as property or
investments, to settle the tax bill.”
Term and whole life insurance
Having a life insurance policy in place protects your assets from inheritance tax and ensures that inheritance tax can be paid quickly with minimal stress.
‘Term’ life insurance and ‘whole’ life plans are two options available to savers.
Term life insurance offers coverage for a defined period, which is typically 10 to 30 years. This is often more affordable but only pays out if the policyholder dies within its term.
Whole-life plans – also known as life assurance – offer lifelong coverage. The premiums are usually higher and typically escalate over time, but the policy guarantees its holder a death benefit.
“Traditionally, whole of life cover for IHT has involved calculating the current IHT due and insuring this with an RPI-linked policy,” says Michaela Pashley, chartered financial planner at Roseum Financial Planning. Any growth on estate above RPI should be calculated and insured, she adds.
“This kind of financial planning can be complex, so I’d always suggest professional advice before taking any action,” Pashley says.
Write insurance policies into trust
Savers need to take one critical step to make sure that their life insurance policies do not get hit with inheritance tax.
“Writing an insurance policy into trust is important because it ensures the payout is
excluded from your estate,” says GSB Wealth’s Howard.
Savers have the option of a ‘bare trust’, which gives beneficiaries an immediate and absolute right to a policy payout, and is often used for specific beneficiaries like children or spouses.
They can also put their policy into a ‘discretionary trust’, which “offers more flexibility, allowing trustees to decide how and when the proceeds are distributed based on the needs of the beneficiaries,” says Howard.
Discretionary trusts are commonly used when there are multiple beneficiaries or when more control over the distribution of funds is required.