The Role of Life Insurance in Inheritance Tax Planning

If you have loved ones who rely on your income, it is recommended that you take out life insurance to protect them should something happen to you. A life insurance policy is designed to pay off debts, such as a mortgage, as well as cover living expenses and provide financial security. But did you know that it is also possible to use life insurance for Inheritance Tax planning?

How are Inheritance Tax and life insurance connected?

If when you die, your estate value exceeds the current threshold of £325,000 (the ‘nil rate band’), then anything over that amount may be subject to Inheritance Tax, which is currently chargeable at 40%.

Because life insurance counts as an asset, there is often confusion over whether the beneficiaries of an estate will have to pay Inheritance Tax on it.

If the amount paid out pushes your estate value over the £325,000 threshold, then the 40% tax will apply. However, married couples and civil partners are able to combine their £325,000 Inheritance Tax allowance, which effectively means a spouse or civil partner has a threshold of £650,000 before tax is payable.

Of course, with property values being so high, it is often not difficult to reach this threshold. Thankfully, however, there is a way to protect life insurance from Inheritance Tax, and that is by putting it in trust.

Putting life insurance in trust for Inheritance Tax planning

Putting a life insurance policy in trust is a straightforward way to ensure it does not count as part of your estate.

A trust works by passing ownership of the life insurance policy to named people (‘trustees’). As it is no longer yours, it cannot be treated as part of your estate when you die. This means that your beneficiaries will receive the full benefit of the policy, without any tax being deducted.

It is important to be aware that there are tax and legal consequences when setting up a trust. Taking advice from an Inheritance Tax planning specialist is therefore strongly advised so that you fully understand what is involved.

How else to use life insurance for Inheritance Tax planning?

Even with your life insurance in trust, your estate may still exceed the Inheritance Tax threshold. So the question is, are there ways to use life insurance for Inheritance Tax planning, effectively using a policy to pay the tax bill?

The answer is yes, in some cases. If it is a ‘whole of life’ policy, also known as ‘life assurance’, then it can potentially be used to cover the Inheritance Tax payable when you die.

Life assurance provides a guaranteed payout when you die, at any time for as long as the policy is in place. This is as opposed to ‘term life insurance’, which only pays out if you die within a specific period, for example 10, 15 or 20 years. Term life insurance is usually designed to cover you for a particular timespan, such as the duration of your mortgage.

Of course, it will depend on the value of your life assurance policy as to how much of the tax bill it will be able to cover. This is why it is important to take advice from a specialist financial planner if you are keen to provide your loved ones with a way of covering any Inheritance Tax due when you die, to make sure the policy will be sufficient.

The good news is that you do have options and, with a little forward planning and expert advice, you should be able to find a way to make things easier for those left behind when you are no longer here. And this in turn will provide you with peace of mind whilst you are here.

Looking to learn more about the relationship between Inheritance Tax and life insurance? Talk to Partridge Muir & Warren.

At Partridge Muir & Warren, we have been providing professional financial, estate and tax planning services Surrey wide since 1969. As chartered financial planners, we are considered to have reached the ‘gold standard’ for our industry, which means even greater peace of mind for our clients.

We offer a comprehensive Inheritance Tax planning service, brought to you by a team of highly skilled chartered financial advisers, investment administrators, tax advisers and legal specialists. This means that you are able to benefit from all-round advice that covers every aspect of your financial and tax related needs.

If you would like to discover how our estate planning service could potentially save you and your loved ones money, you are welcome to get in touch.