Whole of life
Using Life Assurance to Cover your Estate’s Inheritance Tax (IHT)
You can take out life insurance to help cover the cost of any IHT due on your estate when you die. Life cover comes in a few forms, but most often as term assurance or mortgage protection (these are both types of term assurance).
But, did you know that a term insurance policy will expire once you live to a certain age? This means that should you make old bones, this cover is unlikely to still exist.
Another option available which could be more suitable for inheritance tax planning is a Whole of Life (WOL) policy. This will pay the benefit amount when you die – regardless of when that is.
If your policy is held in trust, the proceeds will be paid directly to your beneficiaries allowing them to pay the IHT without delay or complication. This means that your estate can be passed on to those you love, rather than being used to pay a tax bill.
It is important to use an apt trust; otherwise, the proceeds of the policy could be paid to the estate, increasing the IHT liability.
Trusts are Important
Unbiased’s Tax Action 2014 campaign found that £530 million is paid unnecessarily each year in IHT due to life insurance policies not being placed in trust. If your policy is held in trust, your policy payments will be treated as gifts.
Whole of Life for IHT Planning
Whole of Life assurance will generally pay out on the second death of a husband and wife. It is set up this way specifically as IHT is only usually due on the second death (assuming that each spouse leaves the majority of their wealth to the other spouse).
The existence of that second life extends the likely term of the plan as it is dependent on two people dying instead of just one. This usually makes the premium less expensive.
The plan can be set up in a number of ways, but to keep this explanation less complicated, there are two main methods which are as a guaranteed and a reviewable premium. A guaranteed premium starts off a lot higher, but will not change (but for indexing options chosen at outset). A reviewable premium starts off a lot lower, but will ratchet up as you get older (usually reviewed after 10y, then more frequently).
In reality, it can be an expensive solution, but when compared to the 40% IHT that your beneficiaries would have to pay on your excess estate, it is very likely to produce a saving.
Each situation is different, of course, and for some WOL might be the only suitable option. This is usually the case when you have very little in the way of liquid assets (cash and investments). For instance, if your money is locked up in your home or buy to let properties that you do not wish to sell.
It’s not always possible to do all the desired planning in one go; often because, at the time people start IHT planning they may not be able to make large investments / gifts as they aren’t sure what capital they need for themselves. In those cases, our preferred method however is to utilise the WOL to ensure a solution is in place and treat it as a backstop solution. This is if capital is not immediately available, or if you are as of yet still unsure about what income and capital you will want in retirement. We would then work with you over several/many years to reduce your dependency on the WOL plan with other IHT solutions and reduce the cover before it becomes too expensive.
If you are lucky enough to be healthy now, hopefully you understand that you may not always stay that way. Previous ailments make WOL more expensive and sometimes unachievable as you may have become too high a risk. An earlier successful application makes any changes in health irrelevant as life providers can’t re-underwrite your lives.