Is Life Insurance Subject To Inheritance Tax?

Inheritance tax is something that everyone should consider when estate planning for after their death. Although not every beneficiary of a will has to pay an IHT bill because the inheritance tax (IHT) threshold is set at £325,000, you may find that the value of your estate is over this amount.

This means that your heirs could end up having to pay tax on their inheritance. Alternatively, you could take action before your death to minimise or eliminate their inheritance tax burden.

Nobody wants to pay unnecessary taxes! Nobody wants their family, friends and loved ones who will be the beneficiaries of their will to face financial difficulties if they are faced with an IHT bill while they are grieving. Fortunately, a professional financial adviser that is registered in England and authorised and regulated by the financial conduct authority can give you the advice you need to ensure that the value of your estate after your death is either under the £325,000 threshold or that the amount of inheritance tax due is as low as possible.

A financial adviser can also give helpful guidance about the right life insurance for you and how to use the proceeds of the policy to cover any inheritance tax that is due on your estate when you die. They can also ensure that your life insurance payout won’t be subject to inheritance tax when your beneficiaries receive it.

Does life insurance count as inheritance, and is life insurance counted in estate tax?

All taxpayers have a right to an amount tax free on their own estate, i.e. the total value of all the assets they leave after their death. This tax free allowance means that your beneficiaries don’t have to pay inheritance tax on any property, assets, possessions or money they inherit up to the tax threshold of £325,000. If your estate is worth more than this amount, however, inheritance tax (IHT) is charged at a rate of 40% on the part of your estate that is over this sum.

Your estate includes all of your material possessions, such as your car, jewellery, savings, money, and home. The good news is that if you decide to give away your home to your grandchildren or children in your will, the £325,000 tax free IHT threshold will rise to £425,000. That means when you die, the IHT bill your loved ones will be faced with will only be on the part of your estate worth over £425,000. Also, if your spouse or civil partner is the sole beneficiary of your assets, regardless of the value of your estate, they will inherit with no need to pay tax.

However, many people don’t realise that if they have a life insurance policy, their beneficiaries could face a tax bill on the life insurance payout. Money from your life insurance policy is included in your estate, and this means that those who receive a lump sum after your death could have to pay IHT on that money – unless you take action before you die to make sure that the proceeds of your policy will be tax free.

Do you pay inheritance tax on life insurance policies?

If you don’t take action before you pass away to ensure you have dealt properly with your life insurance policy, tax will need to be paid on the proceeds when the policy pays out. But life insurance and inheritance tax aren’t necessarily inevitably joined together.

When it comes to life insurance and inheritance tax, there’s a way of avoiding taxation on the money paid out after you die. You can make sure your life insurance policy is written in trust. This will mean that no tax on life insurance payouts will be levied.

Trusts are legal agreements that allow you to hand over your life insurance policy to a trustee who will become the legal owner, taking care of the policy on your family’s behalf. Putting life insurance in trust offers a host of benefits, including:

  • You get to decide who will receive the funds when your life insurance policy pays out if you write your life insurance in trust. As a result, the lump sum of money from the policy will be paid out directly to your beneficiaries and won’t form part of your legal estate. Since the money won’t form part of the estate value for IHT threshold purposes, your family can avoid inheritance tax when you have a life insurance policy written in trust.
  • Typically, the life insurance provider will pay out the money more rapidly, as when your life insurance isn’t part of your estate, the standard legal steps accompanying a death, such as probate, can be avoided.

Your insurance provider will help you put your life insurance policy in trust as this is one of the services they will provide (often for free). You should be aware, though, that once you put your policy in trust, you cannot adapt it at any future time. Therefore, it’s best to think carefully and take advice from professional financial services providers about the potential benefit to you and your family of opting for a trust.

While no time restrictions exist for putting your insurance policy in a trust, you should consider doing it as quickly as possible, usually straight after taking out the cover.

Is every life insurance policy in trust tax exempt?

Although most life insurances will benefit from tax exemption if you write them in trust, it’s important to be aware that payouts could be subject to income tax at a higher and additional rate if you have a non-qualifying policy. Policies that have payouts subject to income tax usually include investment elements.

It can be difficult when you compare policies to determine which ones are non-qualifying. Therefore, you should use the services of a professional insurance adviser or financial advisor when you compare policies so that they can advise you as to which ones are qualifying and which are not.

Can life insurance be used to pay IHT?

If you compare the various life insurance policies out there, you’ll discover that some are whole-of-life policies. This stays in force until you die and covers any IHT your heirs will need to pay after your death. It’s important to compare the levels of cover available to choose a policy that has sufficient coverage for your needs. For example, if your estate is likely to have a value of £200,000 more than the threshold, you’ll need to choose a policy that pays out £80,000 to cover the bill fully.

For families that require no financial support but you’d like to give them a lump sum after you die to pay for your funeral, debt repayments, or even as a gift, over 50s life insurance could be an option for you, or if you plan to give a family member a valuable gift, taking out a level term policy is a good idea to cover the IHT tax bill on the gift if you die within seven years of giving the gift.