Life insurance and tax
Inheritance Tax (IHT) is a tax on the total value of an individual’s estate in the event of their death.
Inheritance Tax on life insurance
There is normally no IHT to pay if the value of the individual’s estate is below a £325,000 threshold (2019/20 tax year) or they leave everything above the £325,000 threshold to their spouse, registered civil partner, a charity or a community amateur sports club. Whether the estate is above or below the threshold of £325,000 the deceased’s legal personal representatives will still need to report this to HMRC.
The standard Inheritance Tax rate is 40%. It’s only charged on the part of your estate that’s above the threshold. So in short it's the value of the estate that is over the £325,000 that would be taxed at 40%.
If the deceased was married or in a registered civil partnership and is survived by their spouse or their civil partner then their unused benefit is transferred to their spouse or civil partner. Their estate, in turn, will then be subject to IHT when they pass away. But the good news is that their threshold can be as much as £650,000.
£325,000 may sound like a fairly generous threshold, but suddenly it doesn’t seem so much once you factor in the average value of property, investments, life insurance policies and any other assets it no longer seems such a generous threshold. Where upon a time an IHT liability was the preserve of the wealthy it can now be argued that a greater number of the UK population will have or has an IHT liability in the event of their death.
Putting your life insurance into trust
Normally life policies are taken out for family protection or mortgage protection and usually will form part of the individual’s estate for IHT calculation. So the lump sum that would have been used to give the individual’s love ones a financial cushion could be drastically reduced. One way to avoid this outcome is to place their policy under trust.
A Trust is a legal arrangement which allows the owner of a life policy (the settlor) to give their policy to a trusted group of people (the trustees), who look after it. At some time in the future they pass it on to some people from a group that the settlor has decided (the beneficiaries). Subject to the trust chosen the trustees will normally have the discretion about to decide which of the beneficiaries to pass it on to, how much each will get, and when.
An added benefit, it should help to ensure that the money paid out from the life policy can be paid to the right people quickly, without the need for lengthy legal processes. When the settlor dies, your personal representatives will need to obtain probate so that they have the authority to deal with your estate. In England and Wales either a ‘grant of probate or grant of letters of administration’ is issued to your personal representatives. This process takes time and the individual dies without having made a will it takes even longer. Since the trustees are the owners of a policy placed in trust they do not have to go through this process in order to make a claim
For joint life policies, both of you must agree to your policy being placed into a trust.
Please take professional advice if you need more information about IHT, wills or Trusts.