British families have lost £346 million to one common Inheritance Tax mistake
Discover how placing life insurance in trust can save your family thousands in Inheritance Tax.
You are probably already aware that Inheritance Tax (IHT) can reduce the amount your beneficiaries receive when you pass away.
However, you may not know that almost 7,500 families paid increased IHT in a single tax year because of their life insurance arrangements, Insurance Business reports.
Discover the one key insurance mistake these families made, and how you can prepare your estate appropriately to mitigate IHT.
Inheritance Tax bills are rising
As you may know, the amount you can pass down tax-free is determined by the nil-rate bands:
| Tax-free thresholds (nil-rate bands) | Amount (fixed until 2030) | Who can use them |
| Nil-rate band | Up to £325,000 | Everyone – and late spouses or civil partners can claim their deceased partner’s unused nil-rate band. |
| Residence nil-rate band | Up to £175,000 | Anyone with an estate worth £2 million or less* and is passing their main home to a direct descendant – child, grandchild, adopted child, or stepchild. |
*At £2 million, an estate’s residence nil-rate band begins to taper down, disappearing completely at £2.35 million.
So, if your estate meets the above criteria, you could pass on up to £500,000 tax-free to your beneficiaries – or £1 million in combination with your spouse or civil partner. Any amount above these thresholds could be subject to IHT at a rate of up to 40%.
Crucially, these nil-rate bands have been frozen at their current levels until 2030. In fact, the nil-rate band has not increased since the 2009/10 tax year, nor has the residence nil-rate band increased since 2019/20.
As the value of properties, investments, pensions, and other forms of wealth increases long-term, it may come as no surprise that the government’s IHT receipts are going up too. Between April 2025 and September 2025 alone, HMRC reports that families paid £4.4 billion in IHT, which is a £100 million increase on the same period in the previous year.
A life insurance payout could add to your family’s Inheritance Tax liability
There are several ways to mitigate the IHT on your estate. Lifetime gifting, for instance, is a viable strategy for many families.
In addition, ensuring you have an appropriate life insurance package in place means that your family could receive a capital injection when they need it. They may also be able to cover funeral costs and immediate legal expenses more easily, as well as put some of the payout towards the IHT due on your estate.
The Association of British Insurers (ABI) reports that in 2024:
- 99% of whole of life insurance claims were paid out.
- The average value of a whole of life payout was £7,408.
- 5% of general life insurance claims were paid out.
- The average value of a life cover payout was £79,703.
Depending on your needs and circumstances, either whole of life cover or term life insurance could be invaluable when your family is paying IHT.
Placing life insurance in trust usually exempts it from Inheritance Tax
Nearly 7,500 families paid up to £346 million in IHT on life insurance payouts in the 2022/23 financial year. That’s because they missed one simple step: writing their life insurance into trust.
When you set up a trust, you (the settlor) hand over responsibility of the funds or assets directly to the trustee, who is then responsible for managing the trust and distributing the wealth. Placing your life insurance policy within a trust essentially removes it from your estate (subject to certain conditions).
Without doing this, your life insurance payout is likely to be included in your estate for IHT purposes, potentially increasing your loved ones’ IHT burden rather than decreasing it.
Bespoke financial planning may help you reduce the Inheritance Tax levied on your estate
In the absence of proper planning, your family could see much of their inheritance eroded by IHT. If you’re seeking solutions that enable the next generation to keep your hard-earned wealth, we can help.
Get in touch today to discuss:
- How to create an IHT mitigation strategy
- The solutions we’d recommend based on your unique circumstances and goals
- The implementation of key financial planning essentials, such as putting life insurance in trust.
Our financial planners are here to provide bespoke guidance.
Email us at hale@kelland.co.uk, or call 0161 929 8838.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, or trusts.
Note that life insurance and financial protection plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.
Cover is subject to terms and conditions and may have exclusions. Definitions of illnesses vary from product provider and will be explained within the policy documentation.