If your life insurance is not in a trust, then it becomes part of your estate when you die and is subject to Inheritance Tax. If it is placed in a trust, then it is outside of the estate and not liable for Inheritance Tax.

For many people, life insurance is a way for them to protect their loved ones financially. It’s a safety net that means your family will be able to cover costs if the unspeakable happens. But when it comes to inheritance, it can be hard to understand how life insurance actually fits in.

Does it form part of your estate? Will it be taxed? Can your family use it to pay Inheritance Tax? Here, we’ll talk you through everything you need to know, so that you can make the best decisions for your family.

Understanding Inheritance Tax

Before we dive into life insurance, it’s worth a quick recap on Inheritance Tax laws in the UK. 

When someone dies, everything they own is added up to form their estate. That includes property, savings, investments, valuable items, and in some cases, the pay-out from a life insurance policy.

Inheritance Tax (IHT) is charged at 40% on the part of an estate that is above the tax-free threshold, known as the nil rate band. In the UK, this threshold is currently £325,000. You can also pass on an extra £175,000 tax-free if you leave your main home to your children or grandchildren.

Together, these two allowances mean that a person can leave up to £500,000 tax-free. For married couples and civil partners, the allowances can be pulled together, allowing up to £1 million to be passed on without tax.

Anything above that limit is taxed at 40%, which can make a big difference to what beneficiaries eventually get. 

Importantly, Inheritance Tax usually needs to be paid within six months of the date of death, often before probate is granted and the money is released from the estate. That’s why careful planning can make such a difference.

How life insurance fits into a person’s estate

A life insurance policy is designed to pay out a set amount once the policyholder dies. 

Whether that money is then liable for Inheritance Tax depends on how the policy is set up.

If a life insurance policy is held in the person’s name, the money becomes part of their estate when they die. This means it could increase the estate’s value and push it over the Inheritance Tax threshold. In this case, the payout may be taxed at 40% along with the rest of the estate.

However, when a life insurance policy is written in trust, it is legally separate from the estate. 

In this case, the money goes directly to the beneficiaries rather than being counted as part of the estate. This not only protects the money from Inheritance Tax, but also means loved ones can access it sooner, usually within weeks instead of waiting months for probate.

Is writing your life insurance policy in a trust a good idea?

Putting your life insurance policy in a trust can be a great move for estate planning.

Firstly, it can protect the money from Inheritance Tax because the money is no longer counted as part of your estate. Secondly, it can speed up the process of getting the money paid out. This is because the policy is separate from the estate, meaning it can be paid out before probate is complete. 

Another benefit is control. When you set up a trust, you can decide exactly how it is paid out and to whom. You can use it for giving money to family members, charities, or even putting some aside for young beneficiaries when they are older. With a trust, the beneficiaries must follow your instructions.

Lastly, a trust can help protect your loved ones from financial pressure. The payout can be used to pay Inheritance Tax, pay off a mortgage or any other debts whilst they wait for the probate process to complete.

Can you use life insurance to pay Inheritance Tax?

Yes, you can. In fact, a lot of people take out a life insurance policy to help their family pay an Inheritance Tax bill. If your estate value is likely to be higher than the threshold, your family may have to pay Inheritance Tax before they can access the cash in your estate. This can be a tricky situation and cause a lot of financial stress.

By taking out a life insurance policy specifically to cover Inheritance Tax, the bill can be paid straight away. 

Whole life insurance is commonly used for this, as it guarantees to pay out a set amount of money whenever you die. The policy can be written in a trust so that the money is paid directly to your beneficiaries or executors, allowing them to pay the Inheritance Tax bill on time.

Choosing the right type of life insurance and trust

There are two main types of life insurance used in estate planning.

A whole life insurance policy covers you for your whole lifetime and guarantees a payout whenever you die, provided you keep paying your premiums. This type of cover is best for those looking to cover Inheritance Tax.

A term life policy, on the other hand, covers you for a set period, for example, 20 or 30 years, and only pays out if you die during that term. This can be useful to pay back fixed term loans like mortgages, but it won’t help with Inheritance Tax after the policy ends.

The cost of life insurance

One of the main drawbacks of taking out a life insurance policy for Inheritance Tax is that it can be very expensive, especially for older policyholders. 

Whole life policies, especially, can cost a lot of money, as the insurer knows they will eventually have to pay out the sum. Usually, the cost of life insurance is based on your age, health and the amount of cover you need. 

Luckily, a different option exists that can be a much more affordable option.

How Provira can help you pay Inheritance Tax

Life insurance policies can be very expensive, especially for older policyholders. The problem is that Inheritance Tax is due within 6 months, which can be a long time before the estate’s assets are released. This can put a lot of financial pressure on families at an already difficult time.

At Provira, we help families bridge that gap. Our Inheritance Tax loans allow executors to access up to 50% of the estate value within days, giving them the funds they need to cover Inheritance Tax immediately. 

The loan comes with no monthly payments, no credit checks and no need to put down property or any other assets as collateral. And with our loans charging simple interest, not compound interest, you’ll never have to worry about the loan growing out of control.

This can be a much more cost-effective way to pay off Inheritance Tax than life insurance, especially if you are older or in ill-health and do not have a life insurance policy set up already.

Want to find out more? Why not get in touch and speak to our friendly team about your options? Simply fill in this form and our team will get back to you within 48 hours.

Life insurance and Inheritance Tax

Life insurance can be a great way to protect your loved ones and help them pay Inheritance Tax, but it isn’t the only option.

Provira’s Inheritance Tax loan helps executors access up to 50% of the estate value early, allowing them to cover all associated costs quickly.

To learn more about how Provira can support your family throughout the probate process and get them the funds they need to pay Inheritance Tax, get in touch with the team here.