Whole-life cover can be used to cover inheritance tax bills, though experts warn it may not be right for everyone
There has been a “clear increase” in families using life insurance policies to fund future inheritance tax bills ahead of pensions becoming subject to the charge, financial planners have told The i Paper.
Inheritance tax (IHT) is owed on the estate – savings, property and other assets – of someone who has died, but tax-free limits and various exemptions mean that less than 5 per cent currently pay it.
But with pensions – currently exempt from IHT – set to come into the tax’s scope from next year, more families will face bills and so those who expect charges are exploring ways to cover the costs.
Financial advisers have said that they are getting more enquiries from families looking to use whole-life cover – which pays a guaranteed lump sum at death in return for regular payments throughout their life – so that their family can cover bills.
Some advisers even say it is becoming one of the most common conversations with their clients.
People can pass all of their assets to spouses free of IHT, so most people considering cover are looking at a type of policy called “joint life second death”, which covers two people but only pays out after both individuals have passed away.
However, experts warn this sort of cover can be expensive, and therefore is not right for everyone.
Mike Winstanley, director of wealth management at Bentley Reid, said: “Over the past few years, we’ve seen a clear increase in the use of life insurance to fund inheritance tax liabilities, and that has accelerated further as pension assets are expected to fall within the scope of UK inheritance tax from April 2027.
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“It’s now one of the most common planning conversations we have with clients.”
Wealth management firm Evelyn Partners said it was seeing more clients use whole life cover.
Its head of estate planning Ian Dyall told The i Paper: “For those whose estate is likely to attract substantial IHT liabilities – which will be more widespread after pensions are included in estates – taking out whole life cover can be a cost-efficient way of insuring your inheritance tax liability.”
Rob Mansfield, independent financial adviser at Rootes Wealth Management said that he was talking to more clients about this type of insurance policy too.
Who could face IHT bills in future?
Inheritance tax is paid on the estate of someone who has passed away. There’s normally no tax to pay as long as the value of the estate is below £325,000. If you give away your home, or “main residence” to your children – including adopted, foster or stepchildren or grandchildren – your threshold can increase to £500,000.
There’s no tax to pay on everything over this threshold that’s left to a spouse, civil partner, a charity or a community amateur sports club.
On top of this, if you’re married or in a civil partnership and your estate is worth less than your threshold, the unused threshold can be added to your partner’s threshold when you die, meaning they can end up having a threshold of up to £1m.
But although IHT is owed by small numbers currently, this figure is set to grow. This is partly because the £325,000 threshold is frozen, and with inflation the amount of people with estates larger than this will grow.
Another key factor is that pensions are currently exempt from IHT when the estate is calculated, but from next year this will change. Some people have pensions worth hundreds of thousands or even millions of pounds, and if they die without having used much of them, they could be subject to the tax.
How does whole-life insurance work?
Whole-life insurance is a type of life insurance that provides a payout whenever someone dies, rather than if they die during a set period.
One thing it can be used for is covering IHT bills.
Mansfield explains: “It’s difficult to know exactly what the IHT liability will be on death but say you work out there’s a £200,000 tax bill, having an insurance policy that will pay £200,000 when the tax bill is due, can certainly help.”
Dyall adds that you should “crucially” have the policy written into a trust so the eventual payout does not form part of your estate for tax purposes.
A trust is a legal way of managing your assets, but for the purposes of IHT, they can move money out of legal ownership so they are no longer counted as part of your estate when you die.
“If you are married or in a civil partnership, the best option is a joint life second death policy. This means that both of your lives are insured but the policy will only pay out to your beneficiaries on the second death. The first death does not need to be insured as the surviving spouse inherits assets tax-free,” Dyall adds.
Are they worth it?
Whether whole-life cover works for you depends on your specific circumstances, and you would need to speak to a financial advisor for tailored planning.
They can be expensive, but are generally cheaper if you take them out younger. Mansfield explains that for a healthy couple aged 60, they may be looking at £2,760 per year in return for a second death policy paying out £200,000. The policy cost would ramp up hugely if taken out later.
As a general principle, Winstanley says that the cover works best when you know your family will definitely face an IHT bill.
He says: “The classic example is a husband and wife who jointly own their family home and expect it to remain in the estate until second death. There is no intention to sell it, gift it or restructure it.
“In that scenario, the inheritance tax exposure isn’t going anywhere, and insuring it on a whole-of-life basis can make sense. You are effectively converting an uncertain future tax bill into a known, fixed annual cost.”
He says on the other hand, people should be aware that the insurance premiums – the amount paid for the cover – can be very expensive and potentially less worth it if there are other ways to reduce the bill.
“If assets are likely to be gifted or restructured over time — for example cash or investment portfolios — term insurance is often far more efficient,” he says.
This is a type of life insurance that provides financial protection for a fixed period.