Life insurance provides funds on death to meet an anticipated Inheritance Tax (IHT) liability, subject to the premiums being maintained and the policy terms being met. However, life insurance:
- does not avoid the IHT liability, but rather provides an investment vehicle to meet that liability;
- may not be sufficient to meet the full IHT liability (given that asset values and tax rates will change over time); and
- involves the payment of premiums which may be reviewed by the life company on a regular basis.
The cost of life insurance depends upon the gender, age, state of health, lifestyle and personal habits (particularly smoking) of the life assured. The life insurance premiums paid by the life assured will be treated as gifts for IHT purposes, but the gifts will be exempt if they form part of the life assured’s normal expenditure out of income or if they fall within the annual exemption which applies to gifts of capital.
A term insurance policy can be taken out to cover an anticipated IHT liability if death occurs within a specified period of time, typically seven years from the date of a gift. A term insurance policy does not provide any benefit if death occurs after the policy term has expired, and so is considerably cheaper than a whole-of-life policy.
A whole-of-life policy can be taken out to cover an anticipated IHT liability whenever death occurs, and so is considerably more expensive than a term insurance policy.
Writing a policy in trust
If a life policy is not written in trust then the proceeds are paid to the personal representatives of the life assured’s estate once a Grant of Representation (whether that is a Grant of Probate or a Grant of Letters of Administration) has been obtained, and will form part of the estate for IHT purposes. If, on the other hand, a life policy is written in trust then the proceeds are paid to the beneficiaries immediately on death, and will fall outside the estate for IHT purposes. The beneficiaries can then choose to lend the policy proceeds to the personal representatives of the individual’s estate to pay the IHT liability. Writing life policies in trust applies to new life policies taken out as part of IHT planning, or existing life policies such as endowments or Death-in-Service benefits with an employer.