Life insurance is one of the best ways to ensure that your family are provided for after your death. However, when it comes to life insurance and inheritance tax, it is important to be aware of the impact that taxes and in particular inheritance tax, can have on the payout. Read on to find out what to consider regarding life insurance and inheritance tax, how to avoid increasing potential inheritance tax liability and how you can use a life insurance policy to potentially cover an inheritance tax bill.
It is important to remember that tax laws can be complex, and we recommend you speak to a specialist financial or tax advisor regarding your personal position.
Your family will not normally have to pay capital gains tax or income tax on the proceeds of your life insurance policy. However, inheritance tax could be payable and it is important to be aware of this when you are arranging your policy.
Broadly speaking, all individuals have an inheritance tax threshold up to which there is no liability or tax to be paid on, also known as the nil rate band. If a person's estate on death is above this level, there will be a potential standard rate tax of 40% charged on the amount above the threshold.
Broadly speaking, all individuals have an inheritance tax threshold up to which there is no liability or tax to be paid on. If a person's estate on death is above this level, there will be a potential tax of 40% paid on the amount above the threshold.
For more information visit the Inheritance Tax Section on gov.uk.
Many people don't expect inheritance tax to be something that affects them and there are exemptions; most notably on all inheritance between husband / wife / civil partners where they live in the UK. However, if you add up all your assets, including investments, jewellery and other possessions and your property - and then factor in a sizeable life insurance payout, it's easy to see how your estate could exceed the threshold. When you consider the average house in England, Wales and Scotland is worth £268,291, £179,861 and £161,529 respectively and £496,269 in London* you can see how this would be a problem. If you own your own home (or a share in it) your tax-free threshold may increase to £500,000.
* Average house prices obtained for Feb 2021 using gov.uk HPI tool.
If on death a person's life insurance payout was paid into their estate, this could compound any potential inheritance tax liability. Writing the life insurance policy 'in trust' means that when a person dies, the policy will be paid into the trust as opposed to the estate and as a result, is less likely to be counted as part of the estate when calculating any liability. Trusts are normally managed by trustees, who will often be family members or a solicitor.
There are also a number of other benefits to writing your policy in trust. The money paid out from the life insurance will not have to go through probate, which can be a slow process. This means that your dependants should have access to it much faster after you die. Another benefit in some cases, is that writing a policy in trust gives the policyholder greater control over the payout. For example, the policyholder may not want the money to be released from the trust until dependent children reach a specified age, when the policyholder feels that they will be responsible enough to handle the money.
Writing a policy in trust may be free, relatively simple and can be done at any time after you take out the policy, when using the insurer's trust templates. Despite this, it's a step that many people fail to take and as a result, their dependants may end up paying a greater amount of tax than necessary.
It is possible to use a life insurance policy as part of inheritance tax planning. For example, by taking out a policy (usually a whole of life policy) which is sufficient to cover your estimated inheritance tax bill and writing it into trust, your family could have access to a lump sum with which to pay the inheritance tax bill.
If you'd like to compare life insurance term quotes you can use our online comparison tool. It's fast, simple and allows you to instantly view and compare quotes in one search. You can then change your options to see the effect they would have on your premiums and your life insurance payout. If you're ready, compare life insurance term quotes now.
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