It is expected that during this financial year HM Revenue and Customs are likely to collect £2.3bn in inheritance tax (IHT), the product of taxing people’s assets and cash when they die.
A good way to avoid paying any prospective IHT bill is to take out a Life Insurance policy. A life insurance policy can be taken out on the life of the individual concerned or a joint life insurance policy with their partner.
On the event of the insured person’s death, a payout from the policy meets the tax bill, rather than the funds being drained from the inherited estate to do so.
Inheritance tax is currently payable on the amount above £325,000 or, if the last person in a married couple or civil partnership dies, their joint allowance of £650,000. Anything above these amounts will be taxed at 40%, which could leave a hefty bill for any individual.
What are the benefits?
It is important to highlight that any proceeds from an insurance policy would normally form part of the deceased’s estate as they are classed as an asset of that person. However, this would void any reasoning for taking out a Life insurance policy, as this would only increase the value of the estate and would lead to IHT being payable.
This can easily be avoided by making sure that the policy is written in trust for the deceased’s beneficiaries. A beneficiary is chosen by the person or people that are taking out the policy, who they want to receive any of the assets they are giving away.
The money is then paid to the Trust for the benefit of the beneficiaries. This enables a cash lump sum to be made available outside of the deceased’s estate to pay any IHT, leaving the value of the estate intact to pass on to any beneficiaries.
Where can I buy Life Insurance?
Life insurance is available from a variety of places, but is usually purchased from an Independent Financial Advisor, directly from an insurance company or through the internet.
Regardless of where you purchase a Life insurance policy from it is important that you understand the policy and that it provides the right level of cover at a suitable cost.
Many employers are starting to offer life cover to their employees and provided this not paid to your estate on death it will escape IHT.
What policies are available?
The most common and most simple type of Life insurance is called term assurance. A term policy is essentially a temporary policy, which will only pay out if the person insured dies within the term of the policy. This type of policy is usually chosen by someone to cover a mortgage or secured loan and can be paid over period of 20 years. Once the term is completed by the individual, the policy ceases with no cash in value.
Another type of policy called ‘whole of life’ is also commonly taken as life cover, which, as the name suggests, lasts for the whole of the insured’s life. As there is a guaranteed payout in the event of death, premiums for ‘whole of life’ policies tend to be more expensive.
Where can I get advice?
When applying for insurance all premiums are based on age, sex and health (including smoking habits) of the insured. Premiums will vary from person to person, with older people likely to pay higher premiums as insurance providers will consider the risk too great, but for younger people taking out cover should be reasonably cheap.
If you have any doubt as to which policy you should take out, you should seek out professional advice. This can be from an IFA, or even a solicitor or accountant if general advice is sought about wills and any IHT liabilities.
An example of how Life Insurance works
Roger dies owning a house valued at £500,000.
He also has investments totalling £100,000 and an outstanding mortgage of £50,000.
The value of the estate is calculated to be the total assets (£600,000) less the total of the liabilities (£50,000) giving a net estate of£550,000.
The net estate exceeds the IHT limit by £225,000 and therefore there is an IHT tax bill of £90,000.
If Roger had been married and made a will leaving all his estate to his wife there would not be any IHT to pay at the time of his death as transfers between spouses and civil partners are exempt from IHT.
However, at the time of his widow’s death the value of their joint estate would be charged IHT where it exceeded their joint IHT allowances (currently £650,000).
Roger’s executors would have to settle the IHT bill due with the Revenue thereby decreasing the inheritance due to the tax beneficiaries.
But if a sufficiently large insurance policy, written in trust, has been taken out, then that will cover the IHT tax bill instead.