Using life insurance for inheritance tax planning

Many people worry about leaving their loved ones in the lurch after they die, particularly when it comes to money. One of the most common concerns is leaving behind a hefty inheritance-tax (IHT) bill.

According to HMRC, there was a record high in IHT payments in the 2017/18 tax year, with more than £5.2bn handed over to the taxman – 8% more than the previous year, and 92% more than the 2010/11 tax year. In terms of hefty bills, it’s understandable to be concerned – in 2015/16, the average IHT bill was £179,000.

One way to responsibly – and legally – alleviate the burden of IHT is to take out life insurance cover.

How IHT works 

IHT is payable at a rate of up to 40% on the value of your estate above the current IHT threshold of £325,000 (known as the nil-rate band). If you are married or in a civil partnership, any unused portion of your nil-rate band allowance can be transferred to your spouse when you die.

There is an additional tax-free allowance, known as the residence nil-rate band (RNRB), which can be used against the value of your estate if your home is passed to a direct descendant. This tax year, the RNRB is £150,000 for an individual, increasing to £175,000 by 2020/21. This amount can double if you are in a spouse/ civil relationship.

Using life insurance to cover IHT bills 

If you know your estate is going to be liable for IHT when you die, one way to ensure your family can cover the bill is to take out a whole-of-life insurance policy for the amount your estate will owe. This way, your beneficiaries won’t be forced to sell the family home or any other assets in order to pay IHT bills if they're unable to fund the bill from other sources.

As the name suggests, with whole-of-life cover you pay monthly premiums up until you pass away if they're unable to fund the bill from other sources.. Morbid, yes, but when you die, your family will receive a guaranteed tax-free lump sum, which you can arrange to be the same amount as your IHT liability.

As a pay-out is certain, premiums for this type of policy cost more than if you choose a life-insurance policy with a set term. Premiums will also be higher the older you are. If you decide to take out a joint policy, the sum assured is payable upon the death of the last policyholder. That means if your spouse dies before you, you must continue paying monthly premiums until your own death.

It’s important to note that with whole-of-life cover, the policy must be written in trust* – otherwise it will form part of your estate and be liable to tax.

Ways to reduce your IHT liability

If you’re not ready for whole-of-life cover, there are plenty of other ways to reduce your potential IHT liability.

For example, any gifts you make are exempt from IHT, provided they are gifted more than seven years before you pass away. You may wish to take advantage of this by gifting some of your savings to your family now. You can also make regular gifts that will be free of IHT – as long as you can demonstrate that giving away these assets will not affect your standard of living.

You can also gift up to £3,000 each tax year (or £6,000 if you haven’t yet used the previous year’s allowance) without incurring any IHT. Tax rules can be complex and often change, so seek professional tax advice on reducing the size of your estate and whether life cover is right for you.

Protect your loved ones from unnecessary taxes with professional advice from the Telegraph’s Inheritance Tax Advice Service provided by St. James's Place.

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax reflief depends on individual circumstances. 

*Trusts are not regulated by the Financial Conduct Authority

The above article was created for Telegraph Financial Solutions, a member of Telegraph Media Group. For more information on Telegraph Financial Solutions, click here

St. James’s Place representatives represent only St. James’s Place. The Telegraph Investment, Retirement & Tax Planning Advice Service is provided by St. James’s Place Wealth Management plc, registered in England, registered no. 4113955, registered office St. James’s Place House, 1 Tetbury Road, Cirencester, Gloucestershire, GL7 1FP. Telegraph Media Group is an Introducer Appointed Representative of St. James’s Place Wealth Management plc, which is authorised and regulated by the Financial Conduct Authority. Telegraph Media Group Limited, 111 Buckingham Palace Road, London, SW1W 0DT, company registration number 451593.