IHT Planning
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Inheritance tax planning is done to help support your family to retain as much of your wealth as possible, when you pass away
I’d like to start out first of all with saying that full IHT planning should be done by a financial adviser. We are protection insurance specialists and life insurance is just one way to put measures in place to build your inheritance tax plans.
Our advisers are here to make sure that you get the right life insurance policy to protect your family.
It is always a good idea to speak with a financial adviser to determine your IHT planning, so that they can fully explore all options to protect your wealth in line with UK legislation and regulation. We are more than happy to point you in the right direction of a financial adviser that can do this.
What is Inheritance Tax?
Inheritance tax is paid in the UK when someone dies and their wealth is above certain levels.
For a single person the current level of assets that they can have is £325,000* before their family would need to pay inheritance tax. This is known as the nil rate band.
There is no inheritance tax between married couples, which means that when one partner dies, the other can inherit their assets without tax.
When this happens the partner that is alive will typically then gain the IHT allowance that their partner had. To try and make things as simple as possible most people generally say that a married couple has a combined allowance of £650,000*, before their estate would be taxed for inheritance tax upon their death.
An extra thing to know is that at the moment the UK government also allows you to increase your IHT level by what is known as the residence nil rate band. This currently sits at an additional £175,000*. There are specific eligibility criteria and limits to this which is why we suggest that you speak to a financial adviser to make sure you know exactly when your assets reach a level that Inheritance Tax will kick in.
When you know your total nil rate band you can then determine what Inheritance Tax that your next of kin may face. If your assets place you above the nil rate band you are allowed, then the IHT will be set at 40% of the value of your assets above the nil rate band.
Let’s take a very basic example.
- You establish that your nil rate band, the amount of your assets that won’t be subject to Inheritance Tax is £1,000,000.
- Your assets add up to £1,800,000.
- This means that IHT would be due on £800,000 of your estate.
- The Inheritance Tax due on this would be £320,000.
But! There are many ways that a financial adviser can help support you and your family to plan for this.
One route is life insurance and this is where our protection adviser team can help you.
*Accurate at the time of January 2023
What insurances protect against Inheritance Tax?
There are a couple of ways to use life insurance to provide financial protection to cover Inheritance Tax.
- Joint life second death whole of life insurance – This would be the usual way of setting up life insurance for IHT purposes, for a married couple. There is no IHT between a married couple so we wouldn’t want the policy to pay out after the first person dies. That would just add more value to the estate. Instead we specifically arrange a policy that pays our after both partners die, when the taxation will be triggered.
- Single whole of life insurance – This is essentially a first death policy, as only one person is insured. You would typically use this insurance policy for someone that is single and leaving significant assets to their loved ones upon their death.
A key thing with both of these options for life insurance is that they are whole of life. They are designed to keep being active until you pass away. You might have other reasons for life insurance and may set those policies up for 20 years, 32 years, to age 70 or age 90. But for IHT purposes it’s most likely that whole of life insurance will be the most appropriate choice.
It’s important not to arrange a joint life first death life insurance policy for Inheritance Tax planning. If you do this when the policy pays out if will pay to the surviving partner, added to the value of the estate and very likely making the IHT charge even bigger!
There are alternatives to these options, that might be more suited to your needs and our advisers will discuss this with you.
When should I set up Life Insurance to cover my IHT needs?
This can be a tricky one to answer and there is not one rule fits all. With life insurance the younger you are, the cheaper the policy tends to be.
This is because statistics show that you are less likely to die unexpectedly, the younger you are. Also as we get older there is more chance of us developing health conditions that could make the premiums higher.
A lot of people can think that IHT planning is something that people do once they are in their 50s or older, and this is quite common. But it’s always worth having a think about the value of your assets every now and then to see if your estate falls into inheritance tax levels. Remember that property prices can shoot up quite quickly at times and you might find yourself within IHT limits without realising it.
What else do I need to know?
When you arrange a life insurance policy for IHT purposes you really want the policy to be placed into Trust. This is a legal document that means that when the life insurance pays out, the person that you want to receive it should get it far more quickly than if it’s not in Trust.
Probably the most important thing is that placing a life insurance policy into Trust, means that the payout from the insurance is not added to your estate. It’s essential to make sure that the life insurance is not added to the value of your estate, as it will mean that the Inheritance Tax charge will be even bigger than before.
With a Trust another essential part to watch for is a specific section that talks about retaining a terminal illness payout. With most UK life insurance policies they come with a clause that says that will pay out the money if you are diagnosed with 12 months left to live, so that your final time is as comfortable as possible financially. But, if you retain the terminal illness benefit it will again simply add to the estate and likely increase the Inheritance Tax charge. Every situation is individual but it’s quite likely that you will end up deciding not to retain the terminal illness benefit for yourself.
A life insurance policy is just one part of your Inheritance Tax planning and our advisers are here to support you in getting the life insurance that you need, alongside your long-term financial planning.
Video Transcript
Another area where life insurance is very important is when there are things like gifts happening and iht planning that’s all very technical and plenty of jargon in that area. So I’m not going to go into lots of those things, but I will just explain how it works a little bit.
So in terms of gift planning, that’s when somebody gives part of their wealth to someone else and what we’re doing is putting a life insurance policy in place for the seven years from that moment that the gift is made so that if the person who gifts the money passes away and during a seven year period we can then cover the tax that would be potentially due on that money that was given to somebody else. So I’ve got the person giving the money away. We’ve got the person who’s getting it. So what we’re doing is we’re ensuring this person who’s given the money away to make sure that if they do pass away that this person who’s received the money is able to pay the taxation that might happen now over that’s seven year period that taxation does drop over certain periods of time, it keeps dropping and dropping and dropping until we get certain points and our specific policies that are set up for doing this specifically which are known as gift interval policies. You can also do it as well with a regular life insurance policy with just a little bit of a little bit of dancing about in terms of different policy amounts and levels and everything, but that’s something that an advisor can can step in and really help with and with these policies they are put into what’s known as a trust.
Now, a trust is legal documents and it sits with the policy. These sure has a copy. If you have an adviser, your advisor also often keep a copy and you should keep a copy and make sure the people involved are known and essentially in that policy the person who gives the money signs the legal documents say if I pass away and this money pays out, I want it paying for this person over here. And you know if there’s any kind of claim on the policy if I’m terminally ill and the policy pays up early. I don’t want it. I want this person over here to get it. Now there’s a lot of reasons and Technical reasons why we would set it up that way so far too much for us to do in a video. But that is generally how it would work, you then have things like iheritance tax planning. Now that is where we are getting to the stage where people are starting to get into higher levels of wealth and their family might start to to start to experience inheritance tax when they pass away now for a married couple the inheritance tax limit, there’s no inheritance tax between mode couples and that is now currently at 650,000 pounds. So anything above 650,000 pounds will be subject to inheritance tax.
There is also a potential that you can add on a certain amount and increase that amount with your primary residence and the value of that. So it’s always worth while just having a really good idea and having a look as to how much you might be able to extend that amounts before the inheritance tax starts to kick in. What’s really interesting with things like inheritance tax and how important is to look at it. It’s the fact that a lot of people especially with house prices and the way they’ve increased over time A lot of people are in that inheritance tax level limit without even realizing it and so really do try keep an eye. You know, you might be thinking. Oh my house is worth this much now fantastic. That is absolutely brlliant, but just always start trying to keep an eye on that in terms of how what that will mean to your family if you do pass away.
So usually with inheritance tax planning what will happen is is that you’ll often have a married couple and they will say right in the events that we have both died. We want our money going to our children and and this life insurance policy paying to our children because then that will then be able to they’ll be able to pay the government’s the tax that’s needed and then everything can just be done and dusted and they don’t need to worry about suddenly finding all this money to pay the taxation in terms of the inheritance tax planning. In terms of heritage tax planning as well. It is even more important if you are not married if you are cohabiting and because there are the rules and laws in terms of inheritance tax and as accommodating of cohabiting situations and at that point really wants for getting yourself some Financial advice.
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Dr Kathryn Knowles Phd
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This page was written by Dr Kathryn Knowles Phd, an award-winning insurance adviser. To read more about Kathryn please see her bio here
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