If Inheritance Tax (IHT) is a concern for you, taking out a life insurance policy could mean your estate passes to loved ones intact. With some careful planning, a life insurance payout can cover your IHT liability and ensure assets are passed on to your loved ones.

Planning what will happen after your death isn’t easy, but being proactive is important and can help ensure your assets are passed on effectively.

£2.7 billion paid in IHT between April and August 2021

According to figures from HMRC, between April and August 2021, £2.7 billion was collected in IHT. The figure is around £0.7 billion higher than the same period in 2020. Most families don’t need to worry about IHT, but with a standard rate of 40%, it’s important to understand if your estate could be liable.

For the 2021/22 tax year, the threshold for paying IHT is £325,000. If the total value of all your assets is under this threshold, known as the “nil-rate band”, no IHT will be due. If you’re leaving your main home to children or grandchildren, you can also make use of the residence nil-rate band. For the 2021/22 tax year, this is £175,000. In effect, this means most people can pass on £500,000 before IHT is due.

It’s important to note you can pass on assets free from IHT to your spouse or civil partner. You can also pass on unused nil-rate band or residence nil-rate band allowances. So, if you’re planning as a couple, you could pass on up to £1 million of assets to loved ones jointly without worrying about IHT.

The nil-rate band and residence nil-rate band are now frozen until 2026. During this time, it’s likely that the value of assets, from your home to investments, will rise. As a result, more families will need to consider the impact of IHT on their estate. When estate planning, you need to consider how the value of your assets could change over the long term.

How does life insurance protect your estate?

A life insurance policy doesn’t reduce the amount of IHT due. Instead, it provides your loved ones with a way to pay the bill.

If you pass away during the term of a life insurance policy, it will pay out a lump sum to your loved ones. This sum can then be used to pay an IHT bill, ensuring your assets are passed on intact. It can provide you with peace of mind and ensure loved ones aren’t worrying about an IHT bill while grieving.

When using a life insurance policy to pay for an IHT bill, there are some things to keep in mind:

• The policy must be written in trust. Otherwise, the payout could form part of your estate and increase an IHT bill. By placing the policy in a trust, you can remove it from your estate.
• As you want the policy to pay out on your death, you should choose a whole-of-life life insurance policy.
• You can choose how much you want the policy to pay out. You should take some time to understand the value of your estate and how much IHT will be due. Keep in mind that the value of assets can change over time.

There are other steps you can take to manage an IHT bill, but a life insurance policy could be right for you.

With this option, you’ll retain control of your assets. You can keep and enjoy your assets to use during your lifetime. This means you don’t have to gift certain assets or place them in a trust. It’s an option that can provide you with more flexibility to use your wealth as your wish during your lifetime while still knowing you can pass it on to loved ones.

If a life insurance policy could help you, keep in mind that you will need to pay the policy premiums for the rest of your life. How much the premiums are will depend on a range of factors, including your health and lifestyle, as well as the level of cover you need. You should shop around to find a deal that is right for you and offers a competitive rate.

Building an estate plan that matches your goals

Whether a life insurance policy is right for you, or if other steps could help you pass on your estate efficiently, we’re here to help. Please contact us to discuss your estate plan and the impact Inheritance Tax could have.

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 or tax planning.