Life insurance and Inheritance Tax

Following the 2024 Autumn Budget, several aspects of the way inheritance tax works were changed. These include extending the freeze on inheritance tax thresholds until 2030 as well as the announcement that pensions will be part of an estate for inheritance tax purposes from 2027 onwards. However, there are ways to mitigate your inheritance tax bill or even help your beneficiaries pay it off.

Life insurance for Inheritance Tax

Life insurance can be used as a method of funding your inheritance tax (IHT) bill. By arranging a specific type of life insurance in a trust, the life insurance payout money can be kept outside of your estate to be used by your beneficiaries to pay the inheritance tax payable on the rest of your estate. Although some people will sell assets or access funds from within the estate to fund the inheritance tax, others do not wish to deplete the estate in this way or they may not wish to sell an asset.

When assessing the potential inheritance tax liability charged on your estate upon your death it makes sense to consider life insurance as a method of protecting your estate from inheritance tax meaning that you can pass on more of your assets to your family.

If you are not sure whether your estate will be subject to inheritance tax, you can check this using our Inheritance Tax calculator.

When should you consider life insurance for inheritance tax protection?

Life insurance is not needed to pay an IHT bill but it can be desirable. Here are some of the situations where a life insurance for inheritance tax can be useful:

• if the value of your personal estate exceeds your inheritance tax allowance of £325,000 per person or £650,000 jointly with a spouse and you want to pass your estate on to someone other than your spouse
• If you want to prevent the sale of your home or any other valuable asset to pay IHT
• If you want to ensure that any inheritance tax is paid without reducing the assets you leave to your beneficiaries
• If you have made substantial gifts (in excess of your inheritance tax nil rate band) to friends or family in the last seven years as these are deducted on a tapered basis from your inheritance tax allowance first in the event of your death within seven years of the gift.

What type of life insurance policy do I need to pay the inheritance tax on my estate?

• A whole of life insurance policy could be arranged so that life cover continues throughout your life
• The policy should be held in a trust so that the proceeds payable on death fall outside your estate preventing them from adding to your estate and in turn the IHT bill
• The sum assured should be enough to pay your estimated inheritance tax liability or contribute towards it
• The life insurance will payout a tax-free lump sum of money into the trust

If you buy life insurance to pay inheritance tax, you will need to use a trust to allocate the payout to your beneficiaries outside of your estate and you can read more about how and why to do this in our article, "Writing your life insurance in trust – How it works and why you should consider it". A trust is a legal arrangement and although writing your life insurance into trust to pay inheritance tax can be arranged with most life insurance companies, you should take the time to ensure that it correctly represents your wishes and is in line with any will arrangements that you make.

You can learn more about any gifts you have made during your lifetime and how these might affect the inheritance tax payable on your estate in our article, "Inheritance tax (IHT) taper relief on gifts explained".

How to arrange life insurance for inheritance tax

If you wish to arrange life insurance to fund an inheritance tax bill, you will need to select the correct type of life insurance. If you have ascertained that your estate will be subject to inheritance tax and how much this will be you can start selecting it. In most cases, this will be whole of life insurance but in some instances, you may choose a term life insurance to cover the inheritance tax payable on gifts that you have made during your lifetime.

Inheritance tax can be a complex area of taxation and it is best to seek specialist help with this. We have vetted the services of a specialist life insurance broker called LifeSearch* - it provides advice and guidance to find the best life insurance for your needs and the advisers are trained to provide specialist advice around inheritance tax life insurance. LifeSearch advisers will also provide all of the advice and support you need when putting your life insurance in a trust.

You can arrange a call with a LifeSearch adviser* to discuss your circumstances and receive free advice as well as receive up to £100 cashback if you decide to buy life insurance this way.

Other ways to avoid inheritance tax on your estate

Although life insurance written in trust can be arranged to fund the inheritance tax payable on your estate, there are many situations that could make this difficult including:

• You are too sick to qualify for life insurance
• Life insurance costs are outside of what you can afford

There are other simple steps that can be taken to reduce any inheritance tax liability. It is important to note that inheritance tax is not payable between married couples when the spouse leaves the estate to the other.

If you will be leaving assets that exceed the IHT threshold then it can be a simple case of arranging your assets differently. This FREE guide to Inheritance tax contains examples of how people have reduced their inheritance tax bill and instead passed the money on to their family. It is FREE inheritance tax advice that could save you thousands.

Further reading:

• Inheritance explained
• The 10 best ways to avoid inheritance tax
• How to calculate inheritance tax and our free IHT calculator