Understanding Inheritance Tax Insurance: A Growing Necessity
Recent budget changes regarding inheritance tax have prompted an increased interest in life insurance among families looking to safeguard their assets.
Initially intended as a tax for wealthier individuals, inheritance tax (IHT) now affects a larger number of families as real estate prices continue to ascend. This trend is expected to accelerate following the latest government tax revisions.
IHT is imposed on the total value of an estate at the time of death. Estates passed to a spouse or civil partner are exempt from IHT, and if the estate’s value is below the £325,000 threshold, no tax is owed. A further allowance of £175,000 is available for those bequeathing their primary residence to direct descendants, enabling many to transfer £500,000 without incurring tax liabilities.
Unused allowances can be inherited by a spouse or civil partner, allowing couples to potentially transfer £1 million tax-free. In certain regions, particularly in London and the southeast, even modest family homes surpass this limit.
Since the £325,000 IHT allowance has remained unchanged since 2009, more small business owners and farmers will find themselves liable for IHT starting April 2026, as relief provisions become less favorable. Additionally, pensions will be subject to tax starting April 2027.
In light of these changes, many individuals are exploring life insurance options to provide funds that can cover any IHT liabilities, ensuring their heirs retain their inheritance. “We have noted a marked rise in inquiries,” reported Alan Knowles from Cura Insurance. “As we approach 2027, we anticipate that interest will only continue to grow.”
Here are key considerations regarding life insurance and inheritance tax.
How Does Life Insurance Function?
Whole of life insurance plans offer a tax-exempt lump sum to designated beneficiaries upon the policyholder’s death. These plans are intended to remain valid throughout the policyholder’s life, necessitating ongoing premium payments to ensure beneficiaries receive the payout.
By obtaining appropriate coverage, beneficiaries may avoid liquidating assets, including the family home, to handle an IHT bill after death.
Life insurance can also alleviate cash flow challenges that families encounter. IHT is due to HM Revenue & Customs within six months of death; failure to pay results in interest accruing at the Bank of England base rate plus 2.5 percentage points, currently totaling 7.25 percent. This situation can be complicated as properties solely owned by the deceased cannot be sold until probate is finalized, which might take considerable time.
According to Swiss Re, 28,975 whole of life policies were issued in 2023, reflecting a 4 percent increase from 2022.
Individuals who are single can opt for a single-life whole of life plan, while married couples typically select a joint-life second-death whole of life policy. This type of policy is beneficial for IHT considerations, as assets bequeathed to a spouse or civil partner are exempt from IHT.
Determining the necessary coverage involves assessing estate value, anticipated gifts, inflation, and likely growth in property or investment value. “It’s challenging to calculate accurately, so financial advice is recommended,” stated Alan Lakey from CI Expert.
Another insurance solution worth considering is the “gift inter vivos policy,” which protects against the seven-year gifting rule—a provision where gifts made within seven years of death may be subject to IHT.
Under current IHT regulations, you can give away up to £3,000 annually without it being counted toward your estate’s value for tax purposes. Additional allowances include £5,000 wedding gifts to a child or stepchild, and £2,500 to a grandchild.
Gifts exceeding these limits won’t be IHT-free unless you survive for at least seven years following the gift. Should you pass within three to seven years, IHT on the gift tapers from a rate of 32 percent to 8 percent, decreasing by 8 percentage points each year.
The gift inter vivos policy offers coverage for seven years, so if death occurs before the period ends, the policy payout can assist with addressing the IHT bill. The payout decreases as the gift’s IHT liability tapers between three and seven years.
The most affordable policy for a 70-year-old seeking £200,000 coverage costs approximately £118.36 monthly with LV, totaling nearly £10,000 over the seven years. This would suffice to cover 40 percent IHT on a gift valued at £500,000.
Assessing Life Cover Costs for IHT Protection
The cost of these insurance policies varies significantly, depending on the coverage amount required, as well as factors like age, health status, smoking habits, and whether the policy is reviewable or guaranteed.
A reviewable policy typically reassesses premiums at intervals, often every decade for individuals under 70, and more frequently thereafter. It’s important to verify the specific policy terms.
A guaranteed policy maintains a fixed premium until death, although initial costs for reviewable policies are often lower than guaranteed ones but can increase dramatically with age.
For instance, a reviewable single life whole of life £200,000 plan costs around £39.81 monthly for a 50-year-old, while a guaranteed plan would be £218.60 monthly.
Ian Dyall from Evelyn Partners cautioned, “Premiums can rise significantly, sometimes causing even affluent clients to struggle with payments.”
Reviewable policies might be beneficial for those intending to make substantial lifetime gifts. “The advantage of these policies is that as you make gifts, your estate value declines, subsequently lowering premiums,” Knowles noted.
Guaranteed plans are more suitable for individuals who won’t be redistributing assets during their lifetime. For a 50-year-old couple, a joint-life second-death guaranteed £200,000 plan would cost approximately £164.64 monthly, while for a 70-year-old, the cost increases to £378.46.
To enhance affordability, Mike Strutt from Risk Assured suggests pairing a whole of life insurance policy with a term insurance plan, which only offers temporary coverage.
“Term cover works well for assets intended to be gifted in the future, but not for those you plan to retain,” he advised.
Key Takeaways
When acquiring life insurance specifically for IHT coverage, it is advisable to place the policy in a trust. Although the process can be complex and may require legal counsel, the benefits are significant.
The primary advantage is that the payout remains separate from your estate, thus avoiding IHT implications. Additionally, beneficiaries can access the funds without waiting for probate clearance, which is essential for managing an estate’s financial obligations.
“We frequently observe policies that should be in trust but are not,” Dyall noted.
If the life insurance policy is not held in trust, the payout will be included in your estate, potentially increasing its value and the IHT liability that the insurance is meant to mitigate. In the 2021-22 tax year, 6,810 estates incurred IHT on life insurance payouts, accumulating to a total of £819 million, based on data from NFU Mutual.
Furthermore, Matthew Grimes from The Penny Group advised individuals to ensure that obtaining life coverage to offset IHT does not negatively impact their financial situation. For example, avoid depleting pensions or savings excessively merely to meet premium costs.
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