The biggest IHT mitigation mistake you can make
Please be advised that the information in this article regarding QNUPS and IHT is no longer accurate due to the recent changes announced in the UK Budget. Starting in April 2025, the regulations will have significant implications that may affect your understanding of these topics. We encourage you to stay informed and consult with a Soteria Trusts expert to navigate these changes effectively.
Out of the 22,100 estates that paid inheritance tax in 2018/19, over 6,000 of them paid inheritance tax on proceeds of life insurance policies that the deceased owned. The value of those life insurance policies came to a total of £709 million, which means more than £280 million of inheritance tax may have been paid to HM Revenue and Customs (HMRC). This is probably the most common IHT mitigation mistake made yet it can be easily avoided.
Life Insurance and IHT
Inheritance Tax (IHT) is a tax paid on the deceased person’s estate if it is worth over £325,000 or £650,000 per couple. The rate of tax that is paid above these thresholds stands at 40%. An individual’s estate includes their property, savings, ISAs, cash, cars and anything really that belongs to a person. This also includes the sum assured of any life insurance policies they owned and which are claimed following their death.
Life insurance is a common form of financial protection for one’s family. Proceeds from life insurance policies are Capital Gains Tax-free and also Income Tax-free, which makes it a preferred form of ensuring financial stability for your beneficiaries. The bad news is that such proceeds are subject to inheritance tax. This could result in a significant amount of your legacy being removed from the pot of money that would have otherwise financially supported your loved ones upon your death.
Imagine you had life insurance to the value of £500,000 on death. Once you add in the value of your home, savings, and other belongings, you may be surprised by the size of your estate. This can quickly put your estate above the IHT nil rate bands of £325,000 (£650,000 per married couple), and expose your beneficiaries at risk of paying high rates of inheritance tax on the estate.
Life insurance to pay for IHT mistake
It used to be, and still is, a popular way for many Britons to shield their loved ones in case of their premature death, but also as a part of the IHT mitigation strategy. When someone dies, and if IHT is owed, it needs to be paid before loved ones are granted access to the estate. This means they could be forced to foot a bill of thousands of pounds in one go.
That’s why people tend to take out a whole life insurance policy when they know their estate will exceed the IHT thresholds. Sometimes, families calculate and make provision for it, and are aware of having to pay part of the death benefit in order to access the rest of the estate. However, there are also solutions that can prevent this from happening, and leave more money in the hands of your family.
How to avoid taxation on life insurance proceeds
One of the benefits of securing life insurance is the ability to leave a large sum of money payable to your beneficiaries upon your death. And while such proceedings do form part of your estate, there is one way to avoid it:
Putting life insurance ‘in trust’
The simplest way to avoid IHT charges on your life insurance policies is to put them in trust’. A trust is a legal arrangement that appoints trustees, who can be family members or friends, but also solicitors or a professional trust company to look after the policy (or any other assets) on behalf of your beneficiaries until such a time as the beneficiary is intended to benefit.
Importantly, writing your life insurance policy in trust means the pay-out will go directly to your beneficiaries, because assets held in trust do not form part of your legal estate, and thus no IHT will be due.
Related: Benefits of Setting Up a Trust
Trusts have been used as a means to reduce estate taxes for centuries. An additional benefit of putting assets, including your family home or investment property together with life insurance policies into trust is to allow your beneficiaries to access them right after your passing. This is because assets in the trust don’t have to go through probate.
Knowledge is the key to avoiding the biggest IHT mitigation mistake you can make
As the numbers we presented at the beginning of the post suggest, many people buy life insurance without advice, and are not aware that if they don’t put the policy in trust it will be included in their estate and their family could end up being taxed at 40 % for IHT purposes.
The best way to plan and minimise your estate taxes is to talk with a qualified advisor, who can explain different ways of reducing your UK taxes and advise on the best solution to your particular situation and goals.
Get in touch with the team at Soteria Trusts to discuss different ways of reducing your UK taxes today!
We also invite you to join our monthly seminar discussing using trusts and pension structure in UK tax planning.
