Can life insurance help reduce your Inheritance Tax bill? 3 important things to know

If you’re concerned about a potential Inheritance Tax liability when you pass away, life insurance could help your loved ones settle a bill. Find out more here.

According to Statista, 1,828 people died, on average, every day in the UK in 2021.

While no one wants to think closely about their potential demise, considering the consequences of your passing is an important part of your financial and estate plan.

There are practical considerations, such as how you want your assets to be distributed between your loved ones. Furthermore, there are financial ramifications to think about, such as whether your family will have enough to maintain their lifestyle if you’re no longer around.

And, if you’re one of the growing number of people who will likely face Inheritance Tax (IHT) concerns because of the value of your estate, you’ll also need to plan for how your beneficiaries will pay a potential bill.

The right protection can ensure that those close to you will receive financial support when they need it. Plus, one useful benefit of life insurance is that it can help your heirs to deal with a potential IHT bill when it arises.

Keep reading to find out how.

1. Inheritance Tax is liable on the value of your estate when you die

IHT is payable on the part of your estate that exceeds the tax-free threshold. In the 2023/24 tax year – and frozen until 2028 – this “nil-rate band” amount is £325,000.

An additional band, known as the “residence nil-rate band” allows you to pass your home to your children or grandchildren. In 2023/24 – and frozen until 2028 – this is up to £175,000.

(You should be aware that, if the value of your estate exceeds £2 million, the residence nil-rate band is tapered by £1 for every £2 above the £2 million limit. So, the additional allowance effectively ceases to exist if your estate is worth more than £2.35 million, or £2.7 million for couples.)

What this all means is that, if you die, leave your home to a child or grandchild, and the value of your estate is less than £500,000, there will be no IHT to pay.

And, as any unused nil-rate band can be transferred to a surviving partner on death, this has the effect of potentially doubling the available tax-free amount to £1 million.

While this may seem like a large number, rising house and asset prices, coupled with frozen thresholds, mean it’s highly likely that more families will pay IHT in the future.

IHT is usually charged at a rate of 40%, so it could be a sizeable amount if you don’t take steps to mitigate your tax liability.

2. Life insurance can help you pay an Inheritance Tax bill

If you do think you may have an IHT liability when you die, life insurance may be one way to tackle the problem.

If you know that your heirs will be liable for IHT on your estate when you die, you could take out a life insurance policy to cover some or all of this bill.

Many clients take out life insurance for a fixed term – for example, to age 90. If you die before this age, then the policy will pay the sum assured – which your loved ones can use to pay an IHT liability.

If you don’t, it provides you with time to make alternative arrangements or to reorganise your affairs – perhaps by making gifts over several years or placing assets in trust and reducing the value of your estate.

However, if you pass away after the age specified in your fixed-term policy, your family may not receive a payout; as such, whole of life cover can also be considered.

In any case, the money from a life insurance payout can be used to settle the IHT liability. This ensures that your loved ones receive the full value of your estate.

Moreover, it usually means you can settle the tax liability more quickly, resulting in your beneficiaries receiving their inheritance sooner.

By putting life insurance in place, you effectively transfer your IHT bill to an insurance company. You pay a monthly amount, and the insurer provides a lump sum to enable the bill to be paid when you die.

And, acting earlier can offer benefits. Taking out life insurance when you’re younger may give you more time to make gifts to loved ones and for the value of these to fall outside your estate. Additionally, the younger and healthier you are, the cheaper your protection is likely to be.

3. Your life insurance should be placed in trust

When calculating the value of your estate on death, many different types of assets contribute towards the total. This includes property, cash savings, investments and, potentially, the payout from a life insurance policy.

So, if you do put some protection in place, it’s important to think about placing it in trust.

A trust is a legal arrangement that appoints trustees to look after the policy on behalf of your beneficiaries until such a time as they are intended to benefit.

Writing a life insurance policy in trust means the payout will go directly to your nominated beneficiaries, rather than forming part of your legal estate – meaning no IHT will be due on the proceeds.

If you don’t write the policy in trust, you could just make an IHT problem worse as you’ll simply be increasing the size of your estate subject to the tax!

There are other benefits of writing a life insurance policy in trust, including:

· You can ensure the payout goes to the person (or people) you want

· The payout will reach your loved ones more quickly as it will bypass probate.

Setting up a trust is easy, and you can typically do this when you take out your cover, or later on.

Get in touch

If you’re worried about a potential IHT liability, we can help you devise an estate plan to ensure the smooth and tax-efficient transfer of wealth.

We can also help you to put the right protection in place if you need this.

Email us at, or call 0161 929 8838.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

Note that 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.

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