INSURANCE GUIDE
Inheritance Tax and Life Insurance UK
Using whole of life insurance written in trust to fund an IHT liability and protect your estate.
TL;DR
- Whole of life insurance written in trust pays outside the estate and is not subject to inheritance tax.
- The proceeds can fund an IHT bill without beneficiaries having to sell assets to pay HMRC.
- The seven-year rule on gifts means life cover is often used to protect against a failed PET becoming chargeable.
- Premiums for whole of life IHT cover are based on the IHT liability, not the full estate value.
How Inheritance Tax Works
Inheritance tax (IHT) is charged at 40% on the value of an estate above the nil rate band (currently £325,000) and the residence nil rate band (currently £175,000 when passing a home to direct descendants). The tax is payable by the estate before assets can be distributed to beneficiaries. If the estate is primarily made up of illiquid assets - property, a business, investments - beneficiaries may need to sell assets to fund the IHT bill before they can inherit them. Life insurance can provide the cash to pay the bill.
Whole of Life Insurance in Trust
A whole of life policy guarantees a payout whenever the policyholder dies. Writing the policy in trust removes the proceeds from the insured's estate - the money passes directly to the trust beneficiaries outside of probate and is not subject to IHT itself. The trust can be designated to pay the IHT liability directly to HMRC on the estate's behalf, or to provide liquidity to the beneficiaries to pay the bill from the estate.
The Seven-Year Rule and Potentially Exempt Transfers
Gifts made during a person's lifetime become potentially exempt transfers (PETs). If the donor survives seven years from the date of the gift, no IHT is payable on that gift. If the donor dies within seven years, the gift may become chargeable. Life insurance with a decreasing term matching the seven-year taper can protect against this risk at a relatively low premium cost compared to the potential tax liability.
Calculating the Cover Required
IHT cover is sized against the estimated inheritance tax liability - not the full estate value. A financial adviser or estate planner can calculate the projected IHT liability based on the current estate value, applicable nil rate bands, gifts made, and the impact of any IHT reliefs such as business property relief or agricultural property relief. The life policy is then sized to match the estimated liability.
Related Guides
Disclaimer
This guide is for general information only and does not constitute financial or insurance advice. Kaeltripton.com is not regulated by the FCA. Always read policy documents in full before purchasing cover.
Sources
Frequently Asked Questions
Does life insurance written in trust avoid inheritance tax?
Yes. A life insurance policy written in trust means the proceeds are owned by the trust, not the policyholder's estate. They pass to the trust beneficiaries outside of probate and are not included in the estate for IHT calculation purposes. The trust must be established correctly and the policy ownership must genuinely transfer to the trust at inception. A solicitor or financial adviser should set up the trust documentation.
Is a whole of life IHT policy always the right solution?
Whole of life IHT cover is one tool in estate planning. Other approaches - making lifetime gifts, leaving assets to charity, using pensions, or structuring the estate to maximise available reliefs - may reduce or eliminate the IHT liability rather than simply funding it. A qualified financial adviser can assess the full range of options and whether life cover is the most cost-effective approach for a specific estate.
