Currently, many parents across the UK are feeling the strain of the current cost of living crisis and exploring the best ways in which to secure the financial security of loved ones.
Whilst this article should not be considered as financial advice, we hope it provides some areas of consideration when it comes to your life insurance protection and the level of inheritance tax paid when the time times. This is especially poignant if like me you have children who depend on you.
This article was written in collaboration with a leading UK broker, utilising their industry knowledge.
Can you take out life insurance to cover inheritance tax?
Yes, it’s completely possible to take out life insurance to help cover inheritance tax (IHT).
More and more people in the UK are choosing to do this as a growing number of estates are liable to inheritance tax (mainly due to rising house prices).
If the value of your estate is above the tax-free threshold, then you could take out a whole of life insurance policy with a cover amount that matches your potential tax bill.
You can compare whole of life insurance quotes from leading UK insurers, starting from just 27p a day.
You can also write your life insurance policy in trust completely free of charge. This is an important step if you want to avoid paying inheritance tax on the pay out (and further increasing your inheritance tax bill).
Continue reading as we answer some common questions about securing life insurance for inheritance tax:
- What is life insurance?
- What is inheritance tax?
- Which is the best life insurance for inheritance tax?
- Is life insurance subject to inheritance tax?
- Writing life insurance in trust [avoid or minimise IHT]
- How much life insurance do you need to pay inheritance tax?
- How much does inheritance tax insurance cost?
- Other types of life insurance for inheritance tax
What is life insurance?
Life insurance is a type of policy that’s designed to pay out a cash lump sum to your loved ones after you’re gone, either to help minimise the financial impact of your passing or to provide them with an inheritance in the future.
Typically, those looking to cover an inheritance tax bill will take out whole of life insurance, as the pay out is guaranteed when you pass away (unlike term life insurance, where a pay out is only made if you pass away during the policy term).
As well as inheritance tax, life insurance could also help to cover your funeral costs if your family wish. As the UK average cost of dying is £9,200, the funds from your policy could provide a helping hand during a difficult time.
We explain whole of life insurance in more detail below, as well as the benefits of writing your policy in trust to help avoid or minimise inheritance tax.
What is inheritance tax?
Inheritance tax (IHT) is the tax on your estate when you pass away. Your estate includes any property, possessions, money, life insurance policies and other assets you own that you intend to leave behind for your loved ones.
Inheritance tax is currently charged at 40% and is only payable on the part of your estate that exceeds the tax-free threshold of £325,000 (known as the nil rate band).
For example, if your estate is worth £525,000 in total, then you’ll be charged tax on the £200,000 that takes your estate over the threshold (£525,000 – £325,000 = £200,000). 40% of £200,000 equals £80,000 IHT.
Inheritance tax is usually not payable if:
- The value of your estate is below the tax-free threshold of £325,000
- You leave everything above the threshold to your surviving spouse, civil partner, or a charity.
If you’re planning on giving away your home to your children or grandchildren after you’re gone, then your tax-free threshold increases to £500,000 (this is known as the residence nil rate band).
Which is the best life insurance for inheritance tax?
As mentioned, whole of life insurance could be the best type of policy for helping to cover inheritance tax liability on your estate.
This is because it guarantees to pay out when you pass away – unlike term-based policies that only pay out if you pass away during the set term.
Whole of life insurance written in trust could provide a substantial sum assured (pay out amount) for your loved ones. They could use the funds from your policy to pay all or part of the tax bill if they wish.
If you take out this type of cover, you may also have the added benefit of being able to increase or decrease your sum assured during the policy term if your inheritance tax liability changes.
It’s possible to change your whole of life insurance sum assured if the following events occur:
- The value of your estate increases (increasing your tax liability)
- There’s a change to IHT legislation in the UK (such as a change in tax rate or exemptions).
The maximum amount you can increase your sum assured by will depend on the event and the cover amount you had originally secured.
Whole of life insurance for inheritance tax key features:
- Provides lifelong cover and a guaranteed pay out
- Fixed sum assured up to £1,000,000 (depending on your needs and circumstances)
- Available to applicants aged 18 – 84
- Includes free terminal illness cover as standard
- Fixed monthly premiums (starting from just £8 a month)
Is life insurance subject to inheritance tax?
Yes, in normal circumstances, life insurance is considered part of your estate, which means it could be subject to inheritance tax when you pass away.
If the value of your estate is above the £325,000 threshold, then up to 40% tax could be deducted from your policy pay out – resulting in less money for your family.
But when taking out life insurance for inheritance tax planning, you have the benefit of arranging your life insurance in trust so that it’s not taxable.
We explain the process of writing your life insurance in trust below.
Writing life insurance in trust [avoid or minimise IHT]
Writing your life insurance in trust is a free option that allows you to transfer ownership of your policy to someone else (a trustee), so that it doesn’t form part of your estate for inheritance tax purposes.
The process is straight-forward, doesn’t cost anything and is available with most policies arranged through regulated life insurance brokers such as Reassured.
Life insurance written in trust has many benefits, including:
- Avoid or minimise 40% inheritance tax.
When your policy is written in trust, your loved ones won’t have to pay inheritance tax on the lump sum pay out. This is because your policy is no longer considered part of your estate and will be dealt with separately when you pass away. Life insurance in trust can also help to reduce the impact of inheritance tax on your estate, as the proceeds from your policy can help to cover the bill.
The table below shows how having a policy in trust can reduce your estate value and reduce the amount of inheritance tax. Based on taking out £50,000 of cover:
|Life insurance written in trust||Life insurance not written in trust|
|Total estate value||£525,000||£475,000|
|Amount liable to IHT||£200,000||£150,000|
|Potential IHT bill||£80,000||£60,000|
- Avoid the probate process (faster pay out).
Probate is the process of administering your estate after you pass away. Depending on how complicated your estate is, this process can sometimes take many months or years – delaying a life insurance pay out to loved ones. However, when a policy is written in trust (and removed from your estate), it will skip probate altogether. This means your loved ones will receive a faster pay out.
- Determine who gets the pay out and when.
When writing your policy in trust, you can specify your chosen beneficiaries and potential future beneficiaries (such as grandchildren who aren’t born yet), which will offer you peace of mind that the money will go to the right people. You can also specify when your chosen beneficiaries receive the pay out. For example, you could request that your trustee looks after funds if a child is under the age of 18.
How much life insurance do you need to pay inheritance tax?
You can work out how much life insurance you need to pay inheritance tax by working out the value of your estate and any inheritance tax that might be liable.
Value of estate = Assets – liabilities
Your estate consists of anything you own, including:
- Your main property (and any other property you own)
- Stocks, shares and bonds
- Possessions (such as a car, jewellery, and furniture)
- Any life insurance policies not written in trust
- Any gifts made to loved ones in the past 7 years (worth over £3,000).
Liabilities will consist of anything you owe, including:
- Your mortgage(s)
- Personal loans
- Credit cards
Here’s how to work out the value of your estate:
- Add up the value of all your assets
- Add up the value of your liabilities
- Deduct the value of your liabilities from the value of your assets.
Now that you have an estimate of the value of your estate, you can determine how much inheritance tax may be due (40% on any part above the £325,000 threshold) and the pay out you’ll need from your whole of life insurance policy.
For example, if your estate is valued at £500,000, then the amount exposed to IHT will be £175,000. 40% of this amount is £70,000. This means you’ll need to take out a policy with at least £70,000 pay out to help cover this tax bill after you’re gone.
As mentioned, writing your life insurance in trust is essential if you want to ensure that the full pay out isn’t also subject to inheritance tax.
How much does inheritance tax insurance cost?
The cost of life insurance for inheritance tax depends on a range of factors, including information about yourself and the policy you choose.
During the application you’ll be asked about your:
- Smoking status
- Family medical history
Insurers will consider these factors to work out the level of risk you pose and calculate the cost of your monthly premium.
The table below shows example premiums for whole of life insurance, based on a non-smoking applicant in good health for £50,000 and £70,000 of cover:
|Age||£50,000 sum assured monthly premium||£70,000 sum assured monthly premium|
The cost of life insurance varies between different insurers, so it’s important to compare quotes before settling on one policy.
By using a comparison website or a reputable broker, you can compare deals from a panel of top UK insurers to help you find affordable cover to suit your needs and budget.
Other types of life insurance for inheritance tax
Term life insurance
Term-based life insurance provides cover for a set term and will pay out to loved ones if you pass away during the term. This type of policy could be taken out to help cover gift tax (a form of inheritance tax) that’s liable on certain financial gifts you make during your life (known as gifts inter vivos).
Gift tax may be charged on gifts worth more than £3,000, and if you pass away in the seven years after giving the gift. In this instance, you could secure term life insurance with a seven-year term to ensure that if anything happened to you during this time, the policy could help pay off the tax owed.
Term life insurance is usually the most affordable type of cover, starting from around £5 a month.
Over 50 life insurance
An alternative type of life insurance which could provide an inheritance for your loved ones, but might not cover a large tax bill, is over 50s life insurance (also known as an over 50s plan). This policy guarantees acceptance to people aged 50 – 85 and provides up to £20,000 of cover (depending on your age, smoking status and budget).
Over 50 life insurance is usually more affordable than whole of life insurance, particularly if you have a medical condition. You can also take out multiple over 50 plans from different insurers to secure a larger pay out to help cover inheritance tax liability, if this is within your budget.
Quotes start from just £5 a month.
Life insurance for inheritance tax planning: Top Tips
Inheritance tax planning is important if you have a large estate and you’re worried about your loved ones being affected by the potential tax bill.
Here are some tips to help you arrange suitable life insurance to help cover inheritance tax:
- Write your life insurance in trust to avoid inheritance tax on the pay out – this is a free option available with most policies
- Remember that your estate can be left to your spouse or civil partner tax-free and you can give away your home to family members to increase your tax-free threshold
- Financial gifts worth more than £3,000 could be subject to inheritance tax too so you may wish to factor these in when calculating how much life insurance you need
- Compare life insurance quotes to help you find the best deal available to you
- Make sure that you keep up to date with your premium payments during the policy term so that your pay out isn’t compromised
- Use a broker to help you identify your ideal cover amount and secure a policy to suit your needs and budget
Life insurance and inheritance tax FAQS
Is life insurance taxable?
Life insurance isn’t subject to income tax or capital gains tax. However, it could be subject to inheritance tax if the value of your estate exceeds the tax-free threshold, and your policy is not written in trust.
Is life insurance part of an estate?
Yes, the pay out from a life insurance policy is usually considered part of an estate – unless the policy is written in trust.
Are whole of life policies exempt from inheritance tax?
No, whole of life policies are not exempt from inheritance tax if the policy takes your estate above the tax-free threshold, but you could write your life insurance in trust to avoid IHT on the pay out.
Do you pay inheritance tax on life insurance written in trust?
No, you don’t have to pay inheritance tax on life insurance written in trust. This is because the pay out won’t be considered part of your estate when your tax liability is calculated.
What is the inheritance tax on life insurance?
Life insurance that’s not tax exempt would be charged at the standard IHT rate of 40%.
What is the 7 year inheritance tax insurance?
The seven year inheritance tax insurance is essentially a term life insurance policy (also known as a gift inter vivos policy) which can help to cover inheritance tax liability on financial gifts.
How do I avoid inheritance tax after death?
There are several ways you can legally avoid or minimise inheritance tax on your estate. Including:
- Take out a whole of life insurance policy written in trust with a pay out that matches any inheritance tax liability
- Give away your home to your children or grandchildren so that your tax-free threshold increases by £175,000 (up to £500,000 for an individual or up to £1 million for a couple)
- Write your Will so you can better plan for inheritance tax liability and choose how your estate is distributed when you pass away
- Give gifts during your lifetime to reduce the value of your estate (but be aware of the seven year inheritance tax rule).
- Place assets in a trust so they don’t form part of your estate when you pass away
- Leave all or part of your estate to charity as the amount donated will be tax-free.
I know as a Welsh mum that things are very hard at present for many families across the country. As a result, it is more important than ever to consider our loved ones and plan for the future (no matter how far away this may seem right now).