Life Insurance for Inheritance Tax (IHT) Planning 2023

When you die within the UK your next of kin might need to pay tax to the government. The UK government says that if the value of your estate is more than a certain level, then there has to be tax paid to allow your next of kin to have access to what you have left them.

IHT for a single person currently kicks in if you die and your estate is over £325k. For a married couple this increases to £650k as the surviving partner absorbs the IHT allowance of the other person. These figures can sometimes be increased depending upon the value of your primary residence.

IHT is set at 40% of the value of your estate above your inheritance tax allowance.

This blog does not go into the different options that you can take for IHT planning and instead focuses upon life insurance as a potential solution. If you do need IHT planning advice that does not involve insurance please feel free to contact us and we can direct you to trusted financial advisers.

There are a few ways to to do this and the starting point is chatting about the value of your estate now and what you think it might be in the future.  You might not be at IHT levels now but it doesn’t take much for property values to increase and put you into this IHT risk area.

It’s always worth doing a financial double check every year or so, to make sure that you know exactly where you are with things like the value of your home, your pensions, and any other assets that you have.

• Married couples – a joint life second death whole of life insurance policy
• Single or cohabiting people – a single whole of life insurance policy

A whole of life policy is one of the most expensive life insurance policies that you can arrange, because it doesn’t have an end date.  Assuming that your application is accurate and you keep up to date with your premiums, the policy is guaranteed to pay out. This is why it’s more expensive.

Most life insurance policies have an end date of say stopping after 20 years or when you reach age 70, for example. They cost less because if you live past these timeframes the policy stops and the insurer doesn’t pay a claim on your policy. 

If you find that a whole of life policy is too expensive you might want to consider a life insurance policy that lasts to age 90. This is not ideal as it won’t help if you live past this time, but it will be much cheaper.

When arranging life insurance it is common practice to place the policies into what is known as a Trust. This is a relatively simple legal document that tells the insurer who you trust to handle a claim on your life insurance (a Trustee) to pay the money to who you want to receive the funds (a Beneficiary).

Trusts are potentially complicated as there are a lot of things that can determine the right Trust for your needs. It doesn’t help that insurers have different versions and the names aren’t consistent. As an adviser it can be ‘fun’ to say the least when trying to navigate Trusts when it comes to IHT planning. I was supporting someone where we arranged life insurance with three insurers for inheritance tax protection and I have to do three completely different Trusts to avoid the mistakes that you will read about in point 4.

For IHT purposes you must have your life insurance in Trust, if you do not any claim that is paid out will be added to the value of your estate. Even if you are not near inheritance tax levels we strongly advise placing your life insurance into Trust as it means that your loved ones will get the claim payout sooner, as the money can be released without waiting for probate.

We have already covered that when arranging life insurance for IHT purposes you want to aim for whole of life insurance. But, it can be expensive. In your research you might hear a premium and go “Wow, that’s loads cheaper than I was told elsewhere, I’ll take it”. A cheaper premium is always tempting. You just need to fully understand why that is the case.

• Guaranteed life insurance premiums – this means that the premiums you pay will never change. It will be more expensive at first than a reviewable premium.
• Reviewable life insurance premiums – these premiums change over time as you get older. They start off really cheap, but usually increase after 5, 10, 15 and 20 years.

A reviewable premium can work well for some people, but I often speak to people who have set this up in the past and the premiums have now become astronomical and they can no longer afford the life insurance.  When you apply for life insurance ask for the price for guaranteed premiums and reviewable premiums, but also ask for the projected premium increases for the reviewable premiums.

Life insurance for inheritance tax planning can definitely be setup in the wrong way and it can be very costly for your loved ones.

Don’t fall into the following mistakes:

• Married couples – a joint life first death life insurance policy will not do what you want it to do. When one person dies the other will receive the insurance claim payout and this will increase the value of the estate.
• Married couples – make sure your policy is in Trust and don’t rely on potential beneficiary statements! Without a Trust and without specifically naming your Beneficiaries, the payout from a life insurance policy will most likely be added to the value of your estate.
• Anyone – strongly consider if you want to retain a terminal illness payment, which is where the insurer pays the claim before you die if you are terminally ill. If you do not think that you will get through the money before you die, the value will be added to your estate.

These are just some of the ways that life insurance can be done in the wrong way for your needs. If you have life insurance for IHT planning already and feel that you might have made one of these mistakes, please feel free to contact us to see if we can find a solution that will help. Sometimes it means setting up a new policy, other times it will be some signatures to change the Trust so it is right for you.

5. Gift Planning is different

With gift planning the potential inheritance tax that your Giftee will pay will end seven years after the gift is made. During this time the amount of IHT tax that will be due ‘tapers’. This means that the tax amount decreases over time and there are specific ways to set up life insurance for gift taxation. I will be covering this in a future blog.

Our award winning advisers are here to help you make the right decisions when arranging life insurance, to give you peace of mind that the policy you are paying for is going to do what you want it to do.