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Estate planning -
Future-proof your wealth: Using life insurance to tackle IHT
Discover how life insurance options can support you in passing on your wealth more tax-effectively. Gary Jasper, Senior Wealth Planner, explains how protection can support you in passing on your wealth more tax-effectively.
The recent changes to inheritance tax in the UK, announced by Chancellor Rachel Reeves in October 2024, have led to significant concerns for families looking to pass on wealth efficiently. Starting from April 2027, pension pots will be included in a person's estate and subject to IHT. This expansion of the IHT regime has led many individuals and families to seek ways to mitigate the financial impact.
One popular strategy is to use a life insurance policy (also known as life assurance), particularly ‘whole of life’ cover set up in a trust, to help future generations pay the levy. In this article, Gary Jasper, Senior Wealth Planner, explains the key life insurance options, the pros and cons and how protection could support you to pass on your wealth more tax-effectively.
Understanding the changing tax landscape
Currently, most pensions pots sit outside your estate and aren’t included in IHT calculations. However, from April 2027, this is due to change which means more estates will become liable to pay IHT.
IHT is charged at 40% on estates worth more than £325,000. However, if you pass everything to your spouse or civil partner when you die, there’s no IHT to pay. Your unused IHT allowance also passes to your spouse when you die. If you leave your main home to your children or grandchildren, the threshold can increase by a further £175,000 to £500,000. This means a couple who leave their main home to their children or grandchildren have a combined tax-free threshold of £1 million.
However, anyone with a net estate over £2m will begin to see this additional allowance reduced by £1 for every £2 over this threshold, until it is lost.
Recent rule changes for non-domiciled individuals
The rules for non-domiciled individuals in the UK changed significantly with the introduction of the ‘residence based’ rule. This rule, which subjects individuals who have lived in the UK for at least 10 out of the last 15 years to inheritance tax (IHT) on their worldwide assets, will come into effect on 6 April 2025.
Consequently, more non-domiciled individuals will fall within the scope of IHT, impacting their estate planning strategies and facing significant tax liabilities.
The role of life assurance in IHT planning
A life insurance policy held in trust can be an effective way to cover this tax bill, ensuring heirs are not forced to sell assets quickly to pay HMRC within six months of death. Similarly, shorter-term policies can cover IHT on lifetime gifts, which may become taxable if the donor does not survive seven years.
Whole of life protection
This is a type of life insurance which is designed to provide a lump sum payment upon death, which can be used to cover inheritance tax (IHT) liabilities. It is particularly beneficial for individuals with substantial estates who wish to prevent their heirs from having to sell assets to cover tax liabilities.
To ensure that proceeds remain outside of the estate for IHT, it must be placed in a trust. This also ensures swift payment to beneficiaries.
Benefits:
- Financial security: Provides a lump sum to cover IHT liabilities, ensuring your beneficiaries don't need to sell assets or use savings to pay the tax.
- Trust benefits: When set up in a trust, the policy proceeds are paid directly to trustees, bypassing the need for probate and ensuring timely access to funds.
- Flexibility: Customisable policies, including joint-life options for couples.
Drawbacks:
- Cost: Premiums can be high and increase with age.
- Complexity: Setting up a trust requires careful planning and professional advice.
Term protection – covering gifts made during your lifetime
Term protection can be an effective way to cover an IHT liability. This type of policy provides a lump sum payment if the insured dies within a specified term, which can be used to pay the IHT due on their estate.
It is particularly useful for those who have made significant gifts and want to ensure that their beneficiaries are not burdened with a tax bill if they pass away within seven years of making the gift.
Benefits:
- Cost-effective: More affordable than whole of life policies, ideal for temporary coverage.
- Flexibility: Choose the term length to match needs, like covering the seven-year period after significant gifts to reduce IHT.
- Simplicity: Easy to understand with a clear end date and defined coverage period.
Drawbacks:
- Limited coverage: Only covers a specified term; no payout if you outlive it.
- No cash value: Does not accumulate cash value or have an investment component.
- Potential for higher premiums: If you need to renew the policy after the term ends, premiums may be higher due to increased age or changes in health.
- Maintenance: Requires regular review and potential new policies if additional gifts are made.
Let’s look at an example
Mr. Smith gifts £500,000 to his daughter. If he should die within 3 years, the full amount of the gift would be subject to IHT. To protect against this, he takes out a 7-year policy (known as a Gift Inter Vivos). This policy ensures that if Mr. Smith passes away within this period, the insurance will cover the IHT liability on the gift, preventing his daughter from having to pay the tax.
Write insurance policies into a trust
Placing life assurance in a trust offers significant benefits from an inheritance tax (IHT) perspective:
- Reduces the taxable value of your estate, as the policy proceeds are not considered part of your estate for IHT purposes.
- Beneficiaries can receive the full value of the policy without it being subject to IHT, ensuring they have the necessary funds to cover any tax liabilities.
- Provides quicker access to the policy proceeds, bypassing the probate process and offering immediate financial support to your loved ones during a difficult time.
- Control over how and when the beneficiaries receive the funds, particularly useful for blended families or specific beneficiary wishes.
What should you do next?
By planning ahead and incorporating life protection into your IHT strategy, you can effectively manage and mitigate the impact of IHT on your estate.
But these types of policies are complex and should be structured correctly to align with your overall estate strategy. Seeking professional financial advice is essential to ensure the right policies, trust arrangements, and structuring are in place.
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Important information
By necessity, this article can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This article does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
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Author -
Gary Jasper
Senior Wealth Planner
Gary is an experienced wealth manager with over 25 years of success advising high-net-worth clients on investment and inheritance tax planning. Known for building strong, lasting relationships, he specialises in providing tailored financial advice to meet individual client needs.
DISCLAIMER
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