Life Insurance and Inheritance Tax – Forbes Advisor UK


If you have taken out a life insurance policy to provide financial protection for your loved ones, the proceeds of the claim will generally not be subject to income tax or capital gains tax ( CGT) – but inheritance tax (IHT) may be payable if the payment is part of your estate.

Here, we take a closer look at how it works and what steps you can take to avoid paying the IHT on the proceeds of your life insurance policy.

What is inheritance tax?

Inheritance tax is levied on the estate of a person who dies following his death. A person’s estate can include their property, money, cars and other assets, as well as the proceeds of a life insurance policy.

The IHT will generally not be payable if the value of the estate is below the zero rate bracket (NRB) of £ 325,000 or if you leave anything above the threshold to your spouse or civil partner, or a beneficiary. exempt such as a charity.

However, if the value of your estate is greater than £ 325,000 and the above situations do not apply, the portion of your estate above the threshold may be subject to IHT at the rate of 40%.

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How does inheritance tax work for married couples?

Married and PACS couples can share their thresholds and transfer the unused portion of their threshold without IHT to their partner upon their death. This means that a married couple or registered partnership can pass on £ 650,000 before the IHT becomes payable.

In addition, if you bequeath a property to a direct descendant (a child or grandchild), you can benefit from an additional tax-free allowance of £ 175,000. This can raise the combined IHT threshold by a couple to £ 1million.

Do I have to pay inheritance tax on life insurance?

Paying for a life insurance policy will normally be part of your legal estate. If the life insurance proceeds bring your estate above the IHT threshold of £ 325,000, the portion of your estate above this threshold will be taxable at the rate of 40%.

This could result in the removal of a significant portion of the pot of money that would otherwise have supported your loved ones financially upon your death.

Fortunately, however, there are ways to avoid paying the IHT on your life insurance, as we explain below.

Putting life insurance in “confidence”

The easiest way to prevent the IHT from being charged on life insurance is to put your policy in trust. A trust is a legal arrangement that appoints trustees, such as a lawyer, family members or friends, to look after the policy on behalf of your beneficiaries until such time as the beneficiary is supposed to benefit from it.

It is important to note that writing your life insurance policy in trust means that the payment will go directly to your beneficiaries, rather than part of your legal estate, and therefore no IHT will be due.

But there are also many other advantages to writing a trust policy.

First, it will allow you to decide who will be your trustees and who will receive the money from your life insurance policy. Setting up a trust can be especially important if you are not married or in a civil partnership, as it will ensure that your assets go to the intended beneficiaries.

Writing your policy in trust also means that the payment will get to your loved ones much faster because it bypasses probate – the legal process of sorting out a deceased person’s estate.

Setting up a trust is simple and shouldn’t cost you more. Your life insurance provider will be able to help you and it usually does not require more than a signature on your part. While it is usually best to set up a trust the first time you purchase, you can put your policy in a trust at any time.

Can I use life insurance to pay inheritance tax?

The IHT must be paid before your loved ones can access your estate when you die and as a result, they could be forced to fork out thousands of pounds at one time.

If you know that your beneficiaries will be responsible for the IHT upon your death, you can purchase whole life insurance to cover the full amount of the IHT bill. Whole life insurance policies will pay for each death, rather than within a specified time frame (like term insurance).

Again, to prevent the proceeds of the policy from causing an IHT, your whole life policy must be underwritten in trust. Keep in mind that the premium paid for the policy will also help reduce the value of your estate, which can further reduce the amount of IHT owed upon your death.

If your finances are complicated, it’s always best to speak to an independent financial advisor who can help you find the right solution for your taxes and estate planning.

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