Life insurance to cover inheritance tax enquiries on the rise – we explain why 

Life insurance and inheritance tax are often discussed together, as both address financial events that arise after death. But these discussions are on the rise due to changes announced in the August 2024 Budget that could increase the amount of inheritance tax certain estates will need to pay. Life insurance advisers have reported receiving a higher number of enquiries, specifically to arrange life insurance to fund the expected additional inheritance tax that will be due.

Why are some people planning for a higher inheritance tax bill?

In August 2024, Rachel Reeves, the Chancellor of the Exchequer, announced changes that could mean some households would pay more inheritance tax on what they leave behind. The Chancellor outlined reforms that will likely make inherited pensions liable for inheritance tax from April 2027 and that Agricultural and Business Property Reliefs will undergo changes as of April 2026.

Inheritance tax on pensions

As it stands, when a person dies, any unused funds in their pension can be passed on to their beneficiaries without being liable for inheritance tax, but as of April 2027 this will no longer be the case. Pension funds will become liable for inheritance tax at the rate of 40% for any funds that breach allowable inheritance tax thresholds.

Inheritance tax on Agricultural and Business Property

Under current rules, both Agricultural and Business Property assets can be passed to your beneficiaries free of any inheritance tax upon your death but this stands to change from April 2026. Instead of allowing inheritance tax relief on 100% of these types of assets, estates will be limited to receiving full inheritance tax relief on the first £1m. Assets over and above this level will be liable for 50% of the applicable inheritance tax rate, effectively resulting in a tax charge of 20%.

Government consultation closed last week on pensions being brought into the inheritance tax regime and the changes are now set to proceed into formal legislation. However, in the meantime, affected households are seeking advice to understand what this means for them and how the additional inheritance tax charge will be funded. You can read more about the reforms in our detailed articles covering last year's budget announcement, "Pensions to be subject to inheritance tax after Autumn Budget 2024 changes" and "Labour’s Autumn Budget – Four key inheritance tax changes and how they’ll impact you".

Why is life insurance needed to fund inheritance tax?

First and foremost, life insurance is not a requirement to fund your inheritance tax bill. Your beneficiaries can use liquid funds of their own or from the estate to cover the inheritance tax bill. However, they may face difficulty if they do not have access to these funds and must rely on selling assets to raise money to pay the bill. Selling assets to raise funds can be time-consuming and difficult and many factors, such as market value and saleability have to be considered. In some cases, your beneficiaries may wish to retain the assets, especially if they form part of a business that provides income, for example. This is where life insurance can bridge a gap and is the reason why enquiries for life insurance - specifically to cover inheritance tax - are increasing.

Life insurance could be one of the possible solutions for those who are likely to be subject to a higher amount of inheritance tax due to recent changes. If you want to investigate this further, you should speak with a life insurance specialist* who can discuss your needs, recommend the correct type of life insurance and guide you through the application process.

How does life insurance cover inheritance tax?

Life insurance can be arranged to pay a sum of money upon your death directly into a trust for your beneficiaries to provide them with the funds they will need to cover any inheritance tax that is payable on the estate that you leave them. The most common type of life insurance arrangement used to protect against inheritance tax is a whole of life insurance policy but there are circumstances whereby an IHT liability may only exist for a set period of time and so a term life insurance might be used instead. Either way, life insurance must be arranged in a specific way to ensure that the funds are not paid into the deceased person’s estate, thereby further inflating the amount of inheritance tax payable. We explain this in detail in our article, “Life insurance and inheritance tax”.

How to work out if you need inheritance tax planning

The amount of inheritance tax payable on your estate will be determined by the kinds of assets within it, gifts you may have made during your lifetime, what allowances you qualify for and who your beneficiaries are. It can be complicated, so if you don’t know the amount of inheritance tax that will be payable, you should read our article, “Inheritance tax - what you need to know”. If your estate is simple, you can follow our guidance to work out what your beneficiaries could owe or get a FREE inheritance tax check.

It is worth noting that there are several ways in which you can reduce the amount of inheritance tax that could be payable and we explain these in more detail in our article, "12 ways to avoid inheritance tax".

 

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