Have you protected your life insurance policy from Inheritance Tax?

When it comes to providing for your family, having the right financial protection in place can be invaluable. Knowing that your loved ones will be looked after, even if the worst were to happen, can be a huge weight off your mind.

But even if you have life insurance in place, you may not know that the potential payout could be subject to Inheritance Tax (IHT) when you pass away. If this happened, your family may not have enough money to cover their costs.

If you want to find out how to protect your life insurance policy from IHT, read on to learn what you can do.

Financial protection can help support your loved ones if you pass away unexpectedly

Building financial security for your family can be a hugely rewarding task, even if it requires a lot of work. It can be very satisfying to see your loved ones flourish, secure in the knowledge that they do not need to worry about money.

This can be especially true if you have children, as you know that you are giving them the best opportunities in life when it is time for them to fly the nest.

Of course, if you want to ensure that your loved ones can live in comfort and security even if something were to happen to you, taking out protection can be invaluable.

In highly-skilled office jobs, such as IT, you may not consider the prospect of death in service. But in a high-pressure environment, the stress can take a significant toll on your physical wellbeing.

If you work too hard and fail to give your body enough time to recover, you could run the risk of heart attacks or even a stroke.

If this happened, not only would your loved ones be emotionally devastated but they could also struggle financially. This is especially true if you are the main – or sole – breadwinner in your household.

To protect your family from this possibility, having life insurance in place can be invaluable. Even if you were to pass away unexpectedly, your loved ones would receive a sum which enables them to maintain the lifestyle they are accustomed to.

However, you may not know that any payout your loved ones may receive from a financial protection policy could be subject to IHT. This can potentially have very serious consequences, as your family may not be able to get by on the reduced amount.

Before we discuss how to avoid this, here is a quick brush-up on the rules surrounding IHT.

IHT is typically charged at 40% on the value of any assets over a threshold

Depending on how much wealth you have accumulated over your working life, when you pass away your loved ones may have to pay IHT on the value of your estate. Typically, the standard rate of tax stands at 40% of your assets.

This is applied to the value of your wealth above a tax-free threshold called the “nil-rate band” (NRB). In the 2022/23 tax year, this limit is set at £325,000.

If you plan to leave your main residence to your children or grandchildren, then they can also benefit from the “residence nil-rate band”, which raises the threshold by up by a further £175,000. This means that you can pass on a total of up to £500,000 when you die.

In many circumstances, the payout from a life insurance policy will be counted as part of your estate, and so can be subject to IHT. Thankfully, there are ways to avoid this problem.

Putting your life insurance policy in trust means it does not count towards the value of your estate

If you want to ensure that as much of your life insurance policy reaches your loved ones as it can, you may want to put your policy “in trust”.

Essentially, this is a legal arrangement in which you appoint trustees (such as a solicitor, family member, or friends) to look after the policy on behalf of your beneficiaries.

Crucially, writing your life insurance policy in trust means that the payout goes directly to your beneficiaries. This means that the lump sum does not form part of your estate, and so your loved ones will not have to pay any IHT on its value.

There can be other benefits to writing a policy in trust, too. It can give you greater control over the policy. This can be particularly beneficial if you are not married or in a civil partnership, as it can help to ensure that the money goes to your intended beneficiaries.

Another plus is that writing the policy in trust can also mean that your loved ones receive the payout much more quickly. This is because it bypasses probate, the legal process of sorting out an estate.

If you want to protect your life insurance policy from IHT with a trust, you may want to seek professional advice first. Working with us can help to make the process faster and easier, giving you peace of mind that your family will not have to struggle financially after you pass away.

Get in touch

If you want to protect your family’s future in the event of your death, writing your life insurance in trust is an excellent way to achieve this. If you want to know more, we can help. Email enquiries@bowmorefp.com or call us on 01275 462 469.

Please note:

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

Bowmore Financial Planning Ltd is authorised and regulated by the FCA.

More stories

25 Aug 2023 News

How to create a financial plan

25 Aug 2023 News

Retirement investment strategies for high earners


Get in