Life insurance can offer a great way to ensure your loved ones are looked after in the event of your death. It can help to pay off existing debts, funeral costs, and any expenses. It can also be used to assist your loved ones with their future income needs
However, if you have assets over a certain amount, your life insurance can be heavily taxed, leaving a much smaller sum than planned. If your total combined assets including your life insurance exceed the inheritance tax threshold, your beneficiaries will have to pay the inheritance tax due before they are able to gain access to your estate. The life insurance, alongside other assets, will also need to go through probate, which can take months, if not longer to complete.
Luckily, there are ways to mitigate this
What is the Inheritance Tax Threshold?
If your assets are below £325,000, or 325,000 plus the 175,000 Nil Rate Band from residential property. Your beneficiaries will not be liable to pay inheritance tax.
Above this figure, however, the tax burden is 40%, unless you are leaving it to a spouse or civil partner.
This can significantly decrease the amount that you are able to leave behind for your loved ones.
Putting Your Life Insurance into Trust
One way to avoid paying any inheritance tax on your life insurance is to place it into trust. This simply means that a designated trustee is given the responsibility of looking after your insurance until your chosen beneficiary is entitled to it.
This means that it is no longer considered to be a part of your estate and is not subject to inheritance tax. This is also useful to ensure your insurance is paid directly to your chosen friend or family member, without any legal processes slowing down the delivery.
Taking out an insurance policy to cover the IHT bill
So placing your life insurance policy into trust can avoid your beneficiaries paying tax on it. But a life insurance policy placed into trust can also be one way of helping with IHT bills. If you know your combined assets will exceed the IHT threshold, you can take out a policy that will provide enough of a lump sum to cover the IHT bill.
It would need to be a whole-of-life insurance policy, which remains in force until your death and not simply term cover. If its term cover and you outlive the term of the policy, the insurances lapses. So there will be no value to pass on.
For a single person this would normally be a single life plan on their own life written under trust for the benefit of whoever will inherit the estate.
For a couple who are married or in a civil partnership, who are leaving everything to each other on first death, this would be a joint life second death policy, again written under trust for the benefit of who will eventually inherit their joint estates.
When you take out a whole-of-life policy, you pay regular premiums for the rest of your life in exchange for a lump sum payable on death. And so they can be quite expensive.
Although it is a way to spread payments over a long period of time. However, you need to commit to paying the premiums on a long-term basis; if you are unable to pay the premiums later in life, the policy will lapse and all earlier premiums will be lost.
Guaranteed WOL policies are generally written by insurance companies resident in the UK and can therefore constitute a UK situs asset for IHT purposes. A non-dom will therefore need advice on an appropriate trust for their estate to avoid UK IHT on the policy payout.
To place your life insurance into trust, you should:
Decide on your life insurance needs:
This will depend largely on your financial circumstances and the situations of your loved ones that you will be leaving behind.
This is something that should be reviewed on a regular basis as requirements often change.
Choose a life insurance that best works for you:
There are many different products on the market. This is where it can be useful to talk to a financial adviser.
They will help you to work out a plan that suits the needs of you and your beneficiaries.
And help you find the balance between the sum assured and the premiums due.
Choose a trust:
This is usually something you can do at the same time as you take out your insurance policy. For many insurance plans, it is simply set up at the same time as the insurance. Your financial adviser will be able to talk through your options, although you might like to ask a lawyer to look over the final trust deed. Make sure to appoint your trustees too.
The actual trust process is usually free or very low cost, making this an incredibly attractive route for most people.
If you already have a life insurance policy but it has not been placed in trust. It is advisable to do so if you have assets that will exceed the IHT threshold. Or even simply to avoid it forming part of your estate and being subject to a lengthy probate process.
Currently, reports suggest that only 6% of all customers write their life insurance policies in trust and while many have legitimate reasons for not doing so, there are still undoubtedly many who could benefit if they did.
The options for life insurance and trust providers are vast, which is why it can really help to get professional advice.
Get it right and this is one of the most effective ways of boosting the inheritance that you leave for your loved ones or providing a separate means to cover any inheritance tax bill.
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