A growing number of families will soon fall victim to inheritance tax (IHT) and are desperately looking for ways to cut any bill that could end up in their lap if a loved one dies.
Life insurance, written in trust, could well be the answer.
The latest official data shows the number of estates liable for death duty – charged at 40 per cent above a nil-rate threshold of £325,000, or £500,000 if you gift your home to children or grandchildren – will double over the next four years.
Gifting money to children, grandchildren and close family friends is a commonplace way to reduce the value of an estate to mitigate IHT.
But a previously niche financial product – a life insurance policy written in trust – is becoming an increasingly popular way to counteract a future large IHT bill.
Such insurance doesn’t reduce the slice of your estate liable to IHT. Instead, it provides an agreed lump sum on your death to go towards paying any IHT bill that you leave in your wake.
Although it is expensive and not without flaws, life insurance placed in trust can help to protect families from being left with an IHT bill they can’t afford to pay without realising other assets.
Its emergence as an effective tool against the scourge of IHT is confirmed by data acquired by TWM Solicitors under a Freedom of Information request.
The latest official data shows the number of estates liable for death duty – charged at 40 per cent above a nil-rate threshold of £325,000, or £500,000 if you gift your home to children or grandchildren – will double over the next four years
It shows that the value of cover bought in the year to March surged by 18 per cent to £447 million.
Duncan Mitchell-Innes, a partner at TWM Solicitors, of London and Surrey, says: ‘Other than gifting assets, there are fewer and fewer ways to reduce your family’s IHT bill.
‘Life insurance is one of the few routes left, and we have seen an increased number of inquiries for advice in this area.’
Given its increasing use as an anti-IHT weapon, we look here at how this cover works – and, crucially, whether it is the IHT solution you have long been searching for.
HOW LIFE INSURANCE TRUST WORKS
The proportion of estates liable for inheritance tax is expected to double to nearly 10 per cent by 2029.
This is a result of long-frozen IHT allowances – the standard nil-rate threshold has been stuck at £325,000 since April 2009 – which have reduced their effectiveness against mitigating tax.
On top are new rules, kicking in next year, which will result in unspent pensions being included in an estate for IHT purposes.
And even more families could be liable to IHT if Rachel Reeves introduces new measures in November’s Budget, designed to reduce the ability of people to gift big sums ahead of their death.
More families could be liable to IHT if Rachel Reeves introduces new measures in November’s Budget, designed to reduce the ability of people to gift big sums ahead of their death
A lifetime cap on gifts has been much mentioned as a route she could go down.
A conventional life insurance policy is typically bought to protect a family if the breadwinner dies. It’s often purchased at the time a mortgage is taken out, with the amount of cover designed to clear the loan in the event of death. The larger the cover needed, the higher the monthly premium.
A payout from life cover isn’t subject to income tax or capital gains tax. But it will form part of a person’s estate, potentially exposing it to IHT.
But if the life insurance is written in trust, the proceeds on death are not treated as part of the estate. Instead, they can be accessed quickly and used by the executor of the estate to help pay off any IHT tax liability.
By working out what your inheritance tax bill might be, and buying insurance to cover that sum, the executor can use the proceeds on your death to pay it off without having to sell other assets.
WHY SHOULD YOU PUT ASSETS INTO A TRUST?
Putting life insurance into a trust is potentially a shrewd tax planning strategy.
If the policy is for a fixed term, there are no tax traps to watch out for. If it is a whole-of-life policy – providing cover till you die – then any premiums paid up to the point of death will be liable to IHT if you die within seven years of the policy starting.
You do not need to place the policy in trust straight away. But you will need to be in good health when you do so, otherwise the taxman could argue the policy had a value when you put it into trust – and add it to your estate when you die, making it liable to IHT.
You will also need to decide which type of trust is right for you. They come in various forms – for example, a discretionary or flexible trust. Advice from a tax expert is recommended. There are administrative responsibilities such as registering the trust with HM Revenue & Customs, completing regular tax returns and reporting requirements.
HOW MUCH WILL YOU PAY FOR THIS MOVE?
Rachel Griffin, a chartered financial planner at wealth manager Quilter Cheviot, says premiums for life cover written in trust can be expensive, particularly if ‘you’re older or in poor health’.
The policies will need to be for whole-of-life with premiums affected by age, physical condition, type of employment and whether you are a smoker.
The financial advice website Unbiased says average monthly premiums range from £41 at age 30, £62 at 40 and £106 at 50.
Premiums must be paid for the rest of your life, regardless of how much they go up. Most policies are set up with predetermined review dates when premiums are invariably increased, especially once policyholders turn 70. Unbiased says monthly premiums for the over-70s can be as high as £145.
A FINAL WARNING
While life insurance held in trust is sometimes called a super way to pay an IHT bill, it is not suitable for everyone, especially those with modest estates just above the nil-rate IHT thresholds.
Griffin says that while trusts can be useful for estate planning, the ‘reality is far more nuanced.’
She says they can prove expensive, especially for those desperate to help their loved ones – who then end up enjoying a very long life with an ever-increasing monthly premium to fund, and cover they dare not cancel for fear of upsetting those close to them.
A version of catch 22.